The broad-based S&P 500 may have suffered its first down week in quite some time, but that hasn't stopped more than 2,100 stocks in The Motley Fool CAPS database from creeping within 10% of a fresh 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 valuations. Take national insurer WellPoint (NYSE:ANTM) as a perfect example. WellPoint's shares have surged roughly 40% from their 52-week low as the company has capitalized on the implementation of the Affordable Care Act, better known as Obamacare. With its purchase of Amerigroup, WellPoint was able to greatly expand the number of government-sponsored members it covers and has been able to attract hundreds of thousands of members in key markets, such as California. WellPoint is among the rare group of insurers that's already seeing profits from its Obamacare enrollment segment. With the stock valued at just 12 times forward earnings even after its recent run-up, and millions of Americans still left to be insured, WellPoint's run may not be anywhere near done.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
For the first stock near a 52-week high worth selling, I'm calling out a well-known tech giant and suggesting it could be time to lock in those gains and wait for a substantial pullback. Come on down, Microsoft (NASDAQ:MSFT)!
The perennial tech giant has plenty of positives to offer shareholders, and I believe its recent rally is partly deserved. Microsoft's Windows OS remains the dominant force among operating systems worldwide, with OEM revenue growth of 4% in its latest quarterly results released in April. Also, the addition of 1 million new Office 365 Home members, as well as substantial growth in its cloud segments, is cause for applause. In addition, Microsoft was able to snag market share for its search engine Bing: Advertising revenue grew 38%.
Like I said, this is Microsoft we're talking about, and it's a perennial beast. But that doesn't mean its current valuation of $350 billion accurately reflects its growth opportunity over the next couple of years.
For example, many of the factors that have boosted Microsoft's top- and bottom-line results recently are highly cyclical. The release of the Xbox One gaming console after eight years of development certainly brought Microsoft plenty of attention, but the console is unlikely to see this much interest beyond the next quarter or two. Similarly, even with Bing's improved market share, the online advertising sector is highly tied to the health of the economy. With Google still well into control of search market share and U.S. economic growth looking challenged with the removal of QE3, I'd opine that spending on advertising may be shakier than most businesses are forecasting for 2015.
Also consider Microsoft's valuation. Under normal circumstances a double-digit revenue growth coupled with a forward P/E of 15 would be welcome news for investors. Yet, if you dig deeper you'll see that Microsoft's EPS growth is considerably slower, in the mid-single-digit range. The reason is that Microsoft is spending heavily on cloud research and development. My big concern is that beyond Windows and Bing, Microsoft has a very mediocre history of product development and acquisitions, so I'm not sold on Wall Street's growth projections.
If we're looking at pure organic growth coupled with Microsoft's current level R&D spending, shares are about 20%-25% higher than I'd like to see them. This doesn't make Microsoft a bad company in any way, but it could offer an opportunity to lock in some gains and grab shares a few months or years down the road at a much cheaper valuation.
Lights out on this stock
Speaking of a company whose future looks bright on paper but whose valuation is a few years ahead of its time, the next company up on this week's possible "sell" list is SunEdison (NASDAQOTH:SUNEQ).
SunEdison is a provider of solar energy services and solar modules that's expected to benefit within the U.S. and in emerging-market economies like China as the need for solar energy grows. Solar energy costs have come down considerably since the recession which is making it much easier for solar companies to turn a profit. Furthermore, governments around the world have been more than willing to implement solar projects that have boosted solar backlogs across the sector.
In SunEdison's first quarter the company noted that its solar project pipeline had grown to 3.6 GW with a backlog of 1 GW at the end of the quarter. Net sales also grew 23% year over year to $546.5 million, signaling that demand for solar around the globe remains strong.
However, while investors have once again fallen in love with solar companies, I'll play the party pooper here. SunEdison's same quarterly report also pointed to a 260 basis-point decline in gross margins, a $0.2 million drop in free cash flow, and a $0.09 wider adjusted EPS loss than the prior-year period -- all while capital expenditures dipped $10.7 million from the previous year! These are certainly not figures that support a valuation in excess of $6 billion.
Looking ahead, SunEdison isn't expected to turn the corner to profitability until 2015 -- and even then it's only expected to be marginally profitable. Based on Wall Street's 2016 projections, SunEdison is valued at close to 40 times forward earnings despite revenue growth that may slow to just 10%-13% by 2016. There's a lot of built in risk here with regard to the potential for global economic weakness or increased supply from China which could easily wreak havoc on solar pricing and demand. Regardless of how well-diversified SunEdison is globally, it'll be no match for a supply flood from China, were one to occur.
Until SunEdison is able to deliver steady profits, this is a company I'd suggest you keep your distance from.
Trade this Escalade in
Relax Cadillac Escalade drivers, I have no intention of picking on your vehicle. Instead, I'm suggesting that investors in sporting goods and information security company Escalade (NASDAQ:ESCA) consider parting with their shares after a near tripling over the trailing 12-month period.
A number of factors have helped push Escalade share higher. First, the company sold its print finishing operations which could help eliminate some or all of its $20 million in debt and clear the way for Escalade to focus on expanding its business. In addition, Escalade's quarterly EPS growth of late has been impressive. In the first quarter Escalade delivered 33% EPS growth to $0.16 per share as sporting goods revenue improved 10% from the year-ago period.
But just as there have been reasons to buy into Escalade's ongoing turnaround since the recession, there are also reasons why it could be time to hang up your cleats and ring the register. Specifically, Escalade has been using cost-cutting measures to boost its EPS in recent quarters. While that has the effect of boosting margins and EPS temporarily, it's not a long-term solution to genuine organic growth. If you look at Escalade from a historic perspective, it's had a really difficult time keeping its operating margins in the upper single-digit range, which is where they're at now.
To add, although the company sold its print finishing business, it did report a 3% decline in combined information security and print finishing in Q1 from the year-ago period. With my expectation that sales and margin growth will slow, the company's trailing P/E north of 20 just doesn't make much sense.
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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.
The Motley Fool owns shares of, and recommends Google (A shares), Google (C shares), Apple, and WellPoint. It also owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.