The overall market may have shown pockets of weakness from time to time since the recession, but with more than one-third of all Motley Fool CAPS-based stocks trading within 10% or less of a new 52-week high, it's evident that optimism still rules on Wall Street. 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 valuations. In lieu of some very volatile trading days over the past couple of weeks, water utility American Water Works (NYSE:AWK) has inched toward new highs on a somewhat regular basis. While American Water Works had fallen out of favor when stocks could do no wrong primarily because of its slow growth prospects, an environment where risk is reintroduced makes its consistent cash flow and steady and/or increasing utility rates very attractive for risk-averse and income-seeking investors. If volatility continues during this earning season, I would expect American Water Works to continue to draw in new investors.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
Give this company a dunce cap
Without question, for-profit educator DeVry Education Group (NYSE:DV) stunned Wall Street late last week with better-than-expected third-quarter results.
For the quarter, DeVry's revenue declined by 1.5% to $496.1 million as net income slid slightly to $55.5 million, or $0.86 per share, from $56.8 million, or $0.88 per share. Wall Street expected DeVry to earn only $0.75 per share on $493.5 million in revenue. It was a sizable beat that owed to strong gains in student enrollment in Brazil.
While they're a clear beat of Wall Street's expectations, I would hardly call these results cause to send DeVry's share price to a fresh 52-week high. I'll concede that the company's Brazilian enrollment demonstrated strength, but domestic enrollment continues to sag at its flagship DeVry University, with graduate-course takers down 15.1% in March and total undergraduates off another 10.4%. It's possible that the decline in enrollments could continue to slow domestically, but the chances of a real rebound appear slim, with lawmakers still intent on tightly regulating funding to for-profit educators.
DeVry's lack of genuine growth is another key concern. Since tougher lending regulations were instituted, DeVry is on pace for its third consecutive year of falling revenue. In response, it has cut expenses and instituted share repurchases to give the appearance that its profits aren't as stagnant as they really are. Since the end of 2011, net income has fallen 80% from $330 million to just $66 million on a trailing basis.
At just 17 times forward earnings, DeVry might appear cheap, but you're paying a hefty price for what looks like unsustainable cost-cutting and share buybacks. I'd suggest sticking a dunce cap on DeVry and making it sit in the corner until it reflects on how it'll truly grow its top line.
No amount of foundation can cover up this kind of ugly
Shares of personal-care and beauty products retailer Revlon (NYSE:REV) are smoking hot. A Barron's article from a little over a week ago insinuated that Revlon shares are still cheap and that the company could command a $50-per-share valuation if it were to be purchased. At the time of the Barron's publication, this represented about 100% upside in Revlon's share price.
Adding to the bullishness is Revlon's $660 million purchase of the Colomer Group last year from CVC Capital Partners, aimed to expand its product portfolio. Margins in professional cosmetics are pretty high, so a more diverse pipeline should lead to more robust profits for Revlon.
However, what we've witnessed from Revlon is anything but improved earnings results over the past couple of years. In fact, since 2010 it's all been downhill, complete with stagnant domestic growth and no rewards for shareholders (i.e., no dividends or share repurchases).
Furthermore, on New Year's Eve Revlon announced that it would be leaving China and enacting a restructuring charge of about $22 million. Although the move was made to save the company $11 million per year, I can only scratch my head and wonder why Revlon would pack up its bags and leave the fastest-growing industrialized economy in the world. If it's having difficulty breaking into China, how does it hope to gain scale advantages in slower-growing emerging markets around the world?
In its latest quarterly report, Revlon delivered net sales gains of 7% including the negative effect of foreign currency fluctuations -- but keep in mind this includes gains from its Colomer Group acquisition. Removing professional-segment results from the equation, net sales decreased 1.3% inclusive of negative foreign currency translation.
Put plainly, even with the company valued at 15 times forward earnings, investors could be paying far too much for a stagnant business that has repeatedly been unable to expand overseas or grow organically. Until Revlon can demonstrate otherwise to investors, I'd suggest keeping your distance.
A non-passing grade
I'd be reluctant to give ExamWorks Group (NYSE:EXAM), an independent medical-examination provider and Medicare compliance company, a failing grade, but given its current run-up in the wake of ongoing losses and weakening growth, I'd certainly suggest it's not passing muster.
On the surface, everything looks great for ExamWorks. In the fourth quarter, it grew revenue by 13.8%, including 11.9% organic growth, while adjusted EBITDA improved 26.1% from the previous year. ExamWorks is also generating positive cash flow and reducing its losses with each successive quarter.
Despite this, I've seen some disturbing attributes that give me pause at this roughly $1.4 billion valuation.
To begin with, for the full year ExamWorks' organic growth totaled just 7.3%, with the majority of its 18.2% revenue growth coming in the way of acquisitions. While I don't have any problem with ExamWorks purchasing growth, shareholders should understand that there's often a melding process to assimilating new companies. Rarely do multiple acquisitions get incorporated into the buying company seamlessly, so investors may come to expect erratic organic growth in the coming quarters.
There's also the simple fact that ExamWorks is trading at an extremely rich multiple of 90 times forward earnings, yet its growth rate is slowing dramatically. Current Wall Street estimates peg its fiscal 2015 growth rate at a pedestrian 6%, placing its PEG ratio at a mind-numbing 15! Although the company has handily surpassed EPS estimates so far, it's still losing money.
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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