Spain's banks get up to a $125 billion bailout and China cut its interest rates, but persistent worries over global growth haven't been enough to break down the wall of optimism holding stocks up. For optimists, these rallies may seem like a dream come true. For skeptics like me, they're opportunities to see whether companies have earned their current valuations.
Keep in mind that some companies deserve their current valuations. Auxilium Pharmaceuticals
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
One strike and you're out
I often get brow-beaten in the comments section when I try to fundamentally break down clinical-stage biotechnology stocks, so I promise I'll only do that part of the time with Aegerion Pharmaceuticals
The company has precisely one drug in late-stage development. This drug, lomitapide, is a once-daily oral treatment for homozygous familial hypercholesterolemia (just rolls off the tongue, doesn't it). It's Aegerion's hope that the new-drug application it has submitted to the FDA and to Europe's medical governing body will be approved later this year, which will allow it to turn its focus to other lipid-based uses for lomitapide. But there are just a few problems I see with the current setup.
For one, what if Aegerion doesn't succeed? Lomitapide is an almost exclusive eggs-in-one-basket biotech play. Secondly, according to estimates from research firm Global Hunter Securities, lomitapide's peak potential will be roughly $270 million in sales. According to Aegerion, if lomitapide is approved, the company will be profitable by 2014. I tend to disagree with that assumption on the grounds that additional clinical trial costs related to other lipid-based ailments and increased competition will eat into Aegerion's bottom line. Also, if I were an Aegerion shareholder, despite Genzyme and Isis Pharmaceuticals'
If you build it, they will run
For much of the past few months, anything housing-related has been on quite a run. Homebuilders have been reporting stronger-than-anticipated new order growth and the number of remodels being undertaken by homeowners have remained high. But call me a skeptic, because I'm still not sold on Headwaters
The company has been using heavy leverage to take advantage of the recent rebound in housing, but I'm worried that the benefits will be short-lived. As I've discussed previously, there are a significant amount of foreclosed homes either on the market or in the process of getting ready to hit the market that stand ready to drag down home prices further and kill whatever momentum the homebuilding sector had gathered. Headwaters is also carrying, by its own admission, an extraordinarily large amount of debt. Its net debt of $474 million is quickly approaching a level that would be double its market cap. While leverage can be great in times of high growth, it's an added burden during unsettled times.
Considering that Headwaters hasn't produced an annual profit since 2007, has seen half of its revenue vanish in four years, and has precipitously wiped out shareholder equity with debt offerings and share issuances, I'm going to have to pass.
Painting the town green
To continue with the housing theme, what in the heck has gotten into paint and coating maker Sherwin-Williams
On numerous occasions this year, Sherwin-Williams has upped its earnings forecast due to stronger pricing of its paint products. However, there are numerous disruptors that could get in the way of further growth.
Titanium dioxide pigment prices are soaring, for one. This common pigment used in paints could crunch Sherwin-Williams' margins if it isn't able to pass along further price hikes to customers. The company is also dependent on remodeling and homebuilding strength. If people aren't buying homes or remodeling them, then there's little demand for Sherwin's products. But most important, it's paint! It's not a revolutionary new product, and Sherwin-Williams certainly doesn't have a monopoly on the market. It's just paint, and this growth spurt is nothing more than an anomaly by historical standards.
While all three stocks this week present a compelling case for heading higher, the risks of a single drug failing or the country experiencing yet another false bottom in the housing sector far outweigh the possible benefits these three companies can offer shareholders. I'm so confident in my three calls that I plan to make a CAPScall of underperform on each one. The question is: Would you do the same?
Share your thoughts in the comments section below and consider using the following links to add these three stocks to your free and personalized watchlist so you can keep track of the latest news on each company. And to avoid investing in stocks like these, consider getting a copy of our special report: "The Motley Fool's Top Stock for 2012." In it, our chief investment officer details a play he dubbed the "Costco of Latin America." Best of all, this report is free for a limited time, so don't miss out!