With U.S. GDP growth for the third quarter coming in at a better-than-expected 2.8%, it appears the U.S. economy is once again finding its footing, which sent the broad-based S&P 500 to fresh all-time highs yesterday. For skeptics like me, that's an opportunity to see whether companies have earned their current valuations.
Keep in mind that some companies deserve their current valuations. I offer up Jazz Pharmaceuticals (NASDAQ:JAZZ) as an example of a company well-deserving of its recent run higher. Just last week, Jazz reported a 39% increase in net income to $109.4 million as narcolepsy drug Xyrem saw sales spike by 50% while Erwinaze, which treats acute lymphoblastic leukemia, delivered a 39% spike in sales. With Jazz valued at just 14 times forward earnings and having a knack for trouncing Wall Street's estimates under its belt, I'd consider it worth a look on any pullbacks.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
86 this 58
First, visualize me shaking my head back and forth in disgust. Now, pretty much dub this over and over again for nearly every IPO hitting the market these days and we'll be set!
Leading the sell candidates this week is recently IPO'd online job and classified website 58.com (NYSE:WUBA), which is based in China. After pricing its shares at a range of $13 to $15 and then bumping that to $17 prior to its first day of trading on Halloween, 58.com has now more than doubled, closing yesterday at more than $36.
Although comparisons have been made that 58.com is essentially the Craigslist of China, which therefore puts a lot of promise on its potential for growth, the figures up until this point certainly don't speak to a company that should be worth close to $3 billion. Through the first six months of the year, revenue is up 51% but totaled just $58.8 million while it was only marginally profitable. Extrapolated out, we're looking at a company that's valued around 25 times sales and well into the triple digits in terms of P/E.
Another intangible factor that has me concerned is 58.com's management team. Putting aside the concerns from two and three years ago whereby more than a dozen China-based companies cooked their books, I'm worried about the youth of its executive team, with most in their mid-30s and early 40s. I have nothing against youth and certainly believe a forward-looking company is going to need the younger generation to drive innovation, but I also wonder if there's enough experience here to lead a nearly $3 billion company. I'm not convinced and would suggest letting 58.com's profits catch up with its lofty valuation before considering an investment here.
I'll huff, and I'll puff...
Sticking with our China theme, the next sell candidate on deck today is real estate services company E-House (NYSE:EJ).
Let's get some basic things out of the way, like pointing out that E-House isn't a complete disaster. Thanks to housing price inflation in September, when prices increased at their fastest rate in three years, E-House is seeing a huge demand spike in its real estate e-commerce business. Things have been so good, in fact, that E-House was able to lift its full-year revenue guidance from $630 million to $700 million, which was about 10% ahead of Wall Street's expectations. But I remain unconvinced that shares of E-House can trudge higher.
My primary concern here would be the Chinese government itself. There are few growth factors that cause the Chinese government to rethink cooling down its economy... except for housing prices. Having witnessed how quickly the U.S. economy tanked following the housing bubble in 2008-2009, China is being very careful to ensure that lending and home price inflation doesn't get out of hand. It's quite possible that China could both promote spending in infrastructure within China while simultaneously tightening lending standards in order to cool down home price inflation. Were this to happen, we'd almost certainly see E-House's business growth slow.
From a valuation perspective, with the company already at a forward P/E of 18, I'd suggest that much of the recent growth in home prices in China has already been baked into its share price. All things considered, a forward P/E of 18 isn't particularly expensive, but housing price growth in China has been so erratic in recent quarters that I don't think you want to give a company like E-House too much of a premium to begin with.
Headed for a wipeout
Is it me or were the late 1990s seemingly the last time surf clothing was popular? Despite having quite the collection of Quiksilver (NYSE:ZQK) T-shirts in my own closet (apparently showing how out of the times I am), I believe the specialty action sports retailer is just one earnings report away from potential disaster.
Like the other stocks mentioned above, Quiksilver does have its talking points, which signify things are improving. In the company's third-quarter results, it reported a 12% increase in the Asia-Pacific region sales and saw e-commerce revenue improve an impressive 33% to $31 million. Underneath these small improvements, though, is a company still struggling to redefine its identity in a rapidly changing marketplace geared toward younger consumers.
That same earnings report also showed that Quiksilver's namesake brand sales dipped by 10% while domestic sales tanked another 6% to $286 million. Quiksilver simply can't continue to put a Band-Aid on its problems by cutting costs and hoping that Asia and other emerging markets can make up for constantly declining U.S. sales. Without any brand definition Quiksilver is poised to keep struggling.
In addition, profits have been few and far between for this specialty retailer. Quiksilver hasn't produced a full-year profit since 2006 and investors are staring down a forward P/E (assuming it can turn a full-year profit) of nearly 60 in fiscal 2014. Furthermore, it's produced a free cash outflow in three of the past five years.
With Quiksilver having nearly tripled from its lows over the past year, I'd suggest it's a lot closer to a wipeout than from riding the next wave like a champ.
This week's group of three companies serves as a reminder that sell candidates aren't always bad companies, but many are simply out of touch with reality due to emotional investing and unrealistic growth prospects.
Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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