Feel free to log our early-2014 "correction" as a distant memory, because the broad-based S&P 500 is once again within striking distance of another all-time closing 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. Auto parts company Genuine Parts (NYSE:GPC), which you may know best by its NAPA brand, tipped the scales at a fresh 52-week high this week after the company announced its 58th consecutive annual dividend increase and reported full-year results in which its revenue grew 8% and its profits jumped 6%. Despite challenging market conditions in its highly cyclical and somewhat commoditized office products and electronic segments, the resurgence in auto sales continues to provide a positive long-term outlook for Genuine Parts.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
Not so Nimble after all
I've harped on it time and again, but investors' willingness to give IPOs and data center stocks a free pass has simply gone too far. Up first on the possible "sell" docket this week is flash-optimized hybrid-storage platform Nimble Storage (NYSE:NMBL).
All things considered, Nimble has a lot going for it after debuting just two months ago. Nimble priced its IPO at a mere $21, closed its first day of trading near $34, and has since risen past the $50 per share mark. Growth is certainly not an issue with Wall Street calling for 56% top-line growth in 2015 as enterprise customers look for ways to store data more efficiently in data centers for as little cost as possible. Nimble's hybrid platform is incredibly fast, easily scalable, and relatively inexpensive compared to the current standard found in big data centers.
The concern I have with Nimble Storage is that the company is paying little credence to profitability at the moment and is throwing millions of dollars into research and development, as well as marketing expenses. While its customer base has impressively jumped from around 110 in July 2011 to approximately 1,750 in July 2013, its R&D expenses have basically doubled in successive years, with sales and marketing expenses exploding higher from $2.9 million in 2011 to $39.9 million in 2013. Per the company's S-1 prospectus, "We anticipate that our operating expenses will increase in the foreseeable future as we continue to develop our technology, enhance our product and service offerings, expand our sales channels, expand our operations and hire additional employees."
I fully understand the need to pay for growth in the early going, but investors don't seem to understand that losses for Nimble Storage may continue for another two or three years as it grows its workforce and builds up trust in its next-generation disruptive storage product. There's little question in my mind that the growth is there, but at 19 times 2015's aggressive sales growth forecast, and with hefty losses still expected, I'm not pegging Nimble for much additional share price upside.
Masking tepid growth
I'm always skeptical of huge rallies, and one of the reasons I've been particularly skeptical of the broad-market rally in the S&P 500, is that a number of companies have been turning to cost-cutting measures and share repurchases to boost EPS and mask a lack of genuine organic growth. Another offender I've decided to add to this growing list this week in China Biologic Products (NASDAQ:CBPO).
In terms of region and product, China Biologic Products represents an intriguing investment opportunity. China is growing at a considerably brisker pace than the U.S., and the company develops plasma-based pharmaceutical products, giving it a niche product with relatively little competition.
However, China Biologic Products' last quarterly report certainly wasn't anything to write home about. In the third quarter, the company did deliver a 13% increase in operating income as EPS advanced 6% to $0.53, but that was primarily because it cut its total operating expenses by 19% and repurchased 1.48 million shares of its common stock, or 5.5% of its outstanding shares. Having few shares outstanding does theoretically boost EPS, but it also helps to distract investors from a lack of top-line growth.
Also during the quarter, we saw a revenue increase of just $0.1 million to $53.2 million. I'll give China Biologic Products the benefit of the doubt as its Guizhou production facility has been offline for upgrades since June and is unlikely to come back online until the first half of this year. Yet, even excluding this one-time closure, the company is likely on track for a decline in revenue moving forward, to what I suspect will be a 5%-7% growth rate. While not horrible by any means, it's a bit much to pay for a company valued at 15 times forward earnings that chose to repurchase shares rather than pay shareholders a dividend.
Until I see definitive top-line improvement, I'd suggest sticking to the sidelines.
"Kiss" this stock goodbye
With Valentine's Day having come and gone, it's time to put those heart-shaped chocolate boxes back on the shelf for another year, which gives me all the more reason to voice my personal displeasure at confectioner Hershey's (NYSE:HSY) current valuation.
Like the previous companies, Hershey has a number of factors working in its favor. Obviously, we just got through Valentine's Day, which is a bread-and-butter event for the producer of sweets. Also, Hershey boasts incredible brand power. It doesn't need to do much in the way of advertising since it's practically a household name when it comes to sweets, affording it the ability to cut costs through lower marketing expenses, and also allowing it to keep its prices above its peers in many cases.
But, here's the concern I have with Hershey: Cocoa prices are rising, and its top line isn't. Dark chocolate demand has been on the rise around the globe, and cocoa is in short supply, which has pushed the price per ton of cocoa from $2,150 in March of last year to $2,967 for the May 2014 contract. That enormous jump means higher prices for consumers at a time when retail spending is still iffy at best, and it means higher input costs for Hershey.
As I said above, Hershey's brand name affords it the ability to pass along higher costs. These price increases have delivered sales growth of 6%-7% on an annual basis. However, Hershey is currently valued at a frothy 23 times forward earnings and nearly 15 times book value. If the company paid out a premium dividend, I could see dealing with this lofty valuation, but Hershey's current yield is less than 2% annually.
Unless we see a surge in Hershey's bottom-line growth, I'd suggest avoiding this sugar-induced high.
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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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