The S&P 500 has begun the year trading generally sideways, yet 52% of companies (nearly 2,475) in The Motley Fool CAPS database are currently within 10% of a new 52-week high. 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. Power connection device maker TE Connectivity (NYSE: TEL), for example, is frequently among the S&P 500's least short-sold companies, and its first-quarter results demonstrate why. For the quarter, which it reported yesterday morning, TE Connectivity delivered a 6.1% increase in revenue to $3.33 billion as profit rose to $0.82, beating Wall Street's estimates by $0.05. Furthermore, TE Connectivity boosted its full-year revenue estimates to a range of $13.8 billion to $14.2 billion from its prior guidance of $13.65 billion to $14.15 billion as auto market and fiber network demand remains strong. All signs continue to point toward further upside in this company.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
Clinically insane
I've said it before and I'll say it again: The valuations being placed on recently debuted biotechnology companies lately is absolutely insane. This week's candidate is Karyopharm Therapeutics (NASDAQ: KPTI), whose shares have essentially doubled since it debuted in November.
First off, let's not overlook the fact that Karyopharm Therapeutics is bringing a novel approach to cancer research to the table. By focusing on nuclear transport targets, a lightly researched therapeutic target, Karyopharm could hold the key to a competitive advantage in cancer treatments. Just yesterday, for instance, Karyopharm announced phase 1 results from a study involving selinexor (also known as KPT-330) for metastatic colorectal cancer. In that study, out of the 35 patients, 11 achieved stable disease (10 for at least eight weeks), with one patient achieving a RECIST partial response. In other words, there's definitely hope that this treatment pathway will be effective.
How effective, though, remains to be seen, with eight studies ongoing -- five are in the phase 1 dose-escalation or enrollment stage, and another three are preclinical in nature. Despite having an early-stage pipeline and just a handful of clinical and preclinical data to feed off of, Karyopharm ended yesterday's session with a market valuation of a whopping $946 million. That's a truly insane valuation for a company that probably won't have a marketable product -- if all goes perfectly -- any time before mid-to-late 2016.
Also, the eight ongoing studies that Karyopharm is running will quickly burn through its remaining cash on hand. Based on my best estimates, I would peg the annual cash=burn rate at $40 million to $45 million, meaning that without any partnerships, Karyopharm will seek to dilute shareholders with a secondary offering sooner rather than later.
The technology is exciting, but close to $1 billion is a frothy price to pay for a company not even fully out of phase 1 with its lead drug yet.
How much is too much?
Sticking within the health-care sector we have Acceleron Pharma (NASDAQ: XLRN), a clinical-stage biopharmaceutical company focused on developing protein therapeutics to treat various types of cancer and rare diseases.
Similar to Karyopharm above, the research and early excitement of these studies is incredibly encouraging, especially with progression-free survival and median overall survival hitting a stumbling block in terms of big advances for many cancer types. Acceleron's current pipeline is headed by sotatercept, a "protein therapeutic that increase[s] red blood cell levels by targeting molecules in the TFG-beta superfamily," according to its website. Sotatercept is being studied in three mid-stage trials for beta-thalassemia, myelodysplastic syndromes, and chronic kidney disease.
Best of all, it's partnered with Celgene (NASDAQ: CELG) on the development of both sotatercept and ACE-536. Under the terms of its agreement, Celgene will split the development costs of both drugs, will help co-promote in North America, and will be responsible for all rest-of-world marketing and commercial expenses. Not too shabby for Acceleron, considering it attracted a big name financial backer.
But how much is too much? I'd certainly say a $1.6 billion valuation for three mid-stage studies despite the fact that Celgene owns 11% of Acceleron's shares is way too much!
Initial results from its ongoing phase 2 trial involving sotatercept for the treatment of beta-thalassemia demonstrated that 84% of non-transfusion dependent patients treated with Acceleron's drug achieved at least a 1 g/DL increase in hemoglobin. While that's impressive, we're talking about a 25-patient study! I'd like to see how these results translate in a much larger trial.
Even if sotatercept is everything it's cracked up to be, we are probably looking at two years before an approval and another couple of years before it hits $1 billion in worldwide sales. Considering that Acceleron will be sharing that revenue with Celgene, this means Acceleron could be valued at as much as three times sotatercept's sales in 2018 or 2019 in a perfect world, which to me is a bit too optimistic, even with the backing of Celgene.
A real rally-killer
Few companies have had it as well as homebuilding product suppliers over the past two years, with home prices rebounding by double-digits in 2013 and lending rates scraping by at near record lows, which have encouraged on-the-edge homebuyers to take the dive.
Results for Southern and Eastern U.S. homebuilding products supplier Builders FirstSource (NASDAQ: BLDR) are a perfect reflection of this strength, with its third-quarter results reporting in October showing a 38% increase in revenue -- the company's eighth straight quarter of 30% year-over-year sales growth -- as the company reported net income of $12.8 million compared to a loss of $13.6 million in the year-ago period. For all intents and purposes, Builders FirstSource is putting up rapid growth rates.
So why would I dare consider betting against this type of growth? The answer is that neither its growth rate nor the rebound in the housing sector appears sustainable, which should directly affect Builders FirstSource's share price.
The first aspect I believe investors are overlooking is that a 30%-plus sales growth rate is simply unsustainable for even the fastest-growing industrial companies. Builders FirstSource doesn't have truly innovative products so much as it managed to rebound from artificial low home sales in the South and Eastern U.S.
I'd also consider that throughout the U.S., if there are regions of weak home price growth they would be the East Coast and South, the two areas that Builders FirstSource caters to the most. Weaker home price increases could detract investors from purchasing a home, and have the potential to reduce the desire of homebuilders to develop new communities.
Finally, it's a matter of the Federal Reserve scaling back on its economic stimulus known as QE3. The Fed's monthly bond-buying program had the effect of reducing long-term Treasury yields, which help determine mortgage rates. If there's less money going into purchasing these bonds, the artificially low lending rates we've been privy to may begin to rise. As we've witnessed with loan origination applications hitting a nearly two-decade low in December, it doesn't take a big rise in lending rates to send homebuyers scurrying to the hills. With an expectation that interest rates will rise, home suppliers could be the first to feel the pain.
