It may seem like the market has pummeled momentum stocks over the past month, but with one-third of all stocks in The Motley Fool CAPS database sitting within 10% of a fresh 52-week high, a good number of investors would beg to differ. 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. Take a slower-growth utility such as DTE Energy (NYSE:DTE) as a fine example of a company worthy of a new high. DTE and most electric utilities are defensive plays that underperform in rapid growth environments but excel when investors become anxious of slower growth. Utilities like DTE provide electricity, a basic necessity, meaning their cash flow is relatively predictable, leading to few earnings-season surprises. Not to mention that DTE has a premium payout that yields north of 3%.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
Flick the "off" switch
Whereas most electric utilities become strong buys in a downtrodden market, not all utilities will fit the bill. Perhaps no utility finds its way to the top of my blacklist more often than Dynegy (NYSE:DYN).
Dynegy has been a work in progress since the recession, with the company only re-emerging from bankruptcy protection in October 2012. Last year certainly exhibited the strongest progress the retailer of electricity has delivered in years with $227 million in adjusted EBITDA, a near quadrupling from the $57 million in EBITDA reported in fiscal 2012. Dynegy attributed its improved results to higher gas segment energy margins as well as the acquisition of Ameren Energy Resources.
But improved EBITDA doesn't tell the full tale of Dynegy. The company hasn't turned an EPS profit since 2008 and isn't likely to do so until at least fiscal 2015. Its cash flow has also been inconsistent. In the upcoming year, for example, Dynegy estimated that its free cash flow would only be in the $10 million to $60 million range, which certainly doesn't help the company pay down its $2 billion in debt.
There are a number of other factors that could be set to work against Dynegy, including extremely low natural-gas inventories, which could keep natural-gas prices volatile throughout 2014. In addition, weakness in the coal market is set to weigh on Dynegy's efforts to reach profitability.
What this comes down to is a choice to avoid a non-profitable, highly indebted utility like Dynegy that doesn't pay a dividend and to instead trade it in for practically any of its peers.
Take the money and run
Sometimes as an investor, you can't afford to look a gift horse in the mouth, as is the case with Chindex International (NASDAQ:CHDX), the operator of United Family Healthcare hospitals and ambulatory clinics in China.
Chindex shareholders thought they had hit pay dirt in February when the consortium of TPG Capital, Fosun Pharmaceutical, and current Chindex CEO Roberta Lipson offered to take the company private for $369 million, or $19.50 per share. The nearly 14% premium seemed pretty fair, given that Chindex had lost $4 million through the first three quarters of 2014.
But that was then. The new reality for Chindex shareholders following a "go-shop" period is that it did receive a superior offer of $23 per share in cash. Its press release earlier this week also notes that its board of directors deemed the bid superior, and that it would not be contingent on financing or a shareholder vote. The previous consortium will now have the opportunity to match the new bidder.
My big question is: Why would they want to match this bid? We're talking about a company with plenty of potential in a rapidly growing economy that can't seem to get its operating margins out of the 4%-6% range and has produced a net cash outflow in four of the past five years. In the fourth quarter, Chindex did manage to grow its health care service revenue by 12% but saw operating expenses rise 21% as the opening of two clinics was delayed. The end result was a smaller loss of $0.12 per share, but nonetheless still a loss.
In other words, there's very little upside potential left: Shares already trade close to $23, and their value is only propped up by the expectation that the deal will go forward smoothly. With the risk-versus-reward now overwhelmingly swayed toward the risk end, I'd suggest current shareholders cash out their chips.
Good but not great
Echoing our theme from last week, sometimes your best course of action is to recognize when a decent company is just no longer a good value, as is the case with technology solutions and tech intellectual-property owner Rambus (NASDAQ:RMBS).
There have been a number of factors that have sent Rambus to the moon in recent months, including its fourth-quarter report, which highlighted a 28% year-over-year increase in revenue. In its report, Rambus noted benefits from licensing deals with SK Hynix, Micron Technology, ST Microelectronics, and LSI. Also pushing the company higher was research firm Benchmark's buy rating and $16 price target on the company issued last week.
With higher year-over-year royalty revenue, it's hard to argue that things aren't going well for Rambus. But investors need to understand that the royalty revenue business is highly cyclical. Natural ebbs and flows in the sector can reduce component production that utilizes Rambus' intellectual property, which, in turn, can lower Rambus' overall revenue and make it incredibly difficult for shareholders to predict where the company is headed.
If you needed any more proof that Rambus' growth potential isn't in its own hands, all you need to do is look at its performance over the past eight years. Over that period, Rambus has delivered eight consecutive annual EPS losses with no book value growth. Unless, as a shareholder, you believe Rambus is going to score some major patent victories in court (and I personally find these impossible to predict), then investing in this company right now is akin to crossing your fingers and hoping for the best.
Rambus is attempting to move beyond IP revenue and into contract solutions, but with 97% of its revenue coming from royalties, I'd suggesting passing on Rambus.
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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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