A January U.S. budget surplus and more positive housing data are all that was needed to push the broader market higher yet again this week. 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. Flooring specialist Lumber Liquidators (NYSE:LL) might seem a bit pricey on the surface, but its double-digit same-store sales increases driven by higher customer traffic and its revamped advertising campaign could be just the beginning. Let's also not forget that Lumber Liquidators' CEO, Robert Lynch, was voted CEO of the year by our Motley Fool community.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
Check those expectations
Since it often pays to think ahead, I can completely understand why investors share a lot of optimism surrounding Medidata Solutions (NASDAQ:MDSO), a cloud technology software provider that helps drugmakers manage their clinical data. Medidata actually hooked a gigantic client in Sanofi in October when the company chose Medidata's cloud software to store all of its research and development data. This is a company where the concept makes a lot of sense five years from now, but I simply don't see enough demand in the near term to support its current valuation.
Medidata's third-quarter results demonstrated steady sales growth of 21%; however, net income fell 46% and adjusted EPS missed expectations by $0.07. The company's profit guidance for the upcoming quarter, which it's scheduled to report next week, was also light at the time. We're seeing more and more cases in which cloud management companies are forgoing bottom-line profits in favor of expansion, which results in higher expenses and smaller margins. That's a formula that'll work for a short time, but I doubt it'll support Medidata's forward P/E, which is currently north of 40. Investors should check their expectations with Medidata and walk away while they have the chance.
Where's the beef?
I really have nothing against fast-food restaurant Jack in the Box (NASDAQ:JACK) as I feel it's done a wonderful job of emulating McDonald's (NYSE:MCD) by remodeling its restaurants and revitalizing its menu with healthier food options; but even the highest-quality restaurants stumble now and then.
McDonald's has run into trouble lately overseas with decreased customer traffic in Europe and Asia, as well as pricing pressure on its food items domestically. Jack in the Box and McDonald's share many similarities in that they'd both like to raise prices to accommodate higher food costs, but doing so, especially on their value menu items, could alienate some of their faithful customers. Similarly, the removal of the payroll tax holiday is going to leave the average taxpayer with $1,000 less in their pocket this year. That could dissuade consumers even further from eating out at even the cheapest fast-food establishments, like McDonald's and Jack in the Box.
One prime difference between the two is that McDonald's at least has its own signature coffee blend whereas Jack in the Box doesn't. Unfortunately for Jack in the Box, its commercial figure ("Jack") and not its food is the most identifying factor of the company. With Qdoba sales dramatically lagging behind Chipotle Mexican Grill, food costs rising, and the company valued at a spendy 20 times this year's profit, I'd suggest putting these patties back in the freezer for the time being.
Let's not get the party started
To continue with the theme of picking on restaurants, let's move to the more casual-dining establishment Fiesta Restaurant Group (NASDAQ:FRGI). Like the previous two companies mentioned here, the results have been decent. Fiesta, the owner of Pollo Tropical and Taco Cabana restaurants, noted a 5.8% increase in revenue in its latest quarter and a 50% increase in net income to $3.6 million from $2.4 million. Pollo Tropical led the way with a 5.9% increase in customer traffic and a 1.1% improvement in average check price.
But, like the previous companies on this list, there's cause for concern that its share price may be way ahead of realistic expectations. For one, Fiesta forecast that cost inflation would eat into margins by 50 to 60 basis points. Considering the cost pressures that Chipotle Mexican Grill has alluded to recently, I think these estimates may wind up being a bit light. Second, I think the company's estimates for traffic growth may be a bit optimistic considering the payroll tax increase. Finally, I'd expect its costs to rise as it makes plans to add 14 to 17 new restaurants this year. Tighter margins and higher costs will make Fiesta's forward P/E of 26 seem awfully scary.
This week I'm choosing to focus not on extremely poor companies, but merely solid business models that have been drastically overpriced in recent months given the amount of challenges they'll face over the next one to three years.