The Federal Reserve's monetary easing, known as QE3, may soon come to an end, but that appears to be of no consequence to the nearly 38% of stocks in the Motley Fool CAPS database that are within 10% of a new 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 current valuations. East coast regional bank M&T Bank (NYSE:MTB), for instance, has bucked the past week's volatility and trudged higher on the prospect of higher net interest margins. The thesis here is that, if the Federal Reserve pares back its bond buying, then lending rates will rise, resulting in a beefier net interest margin, and higher bottom-line profits for M&T. As a conservative bank that's focused on traditional loan and deposit growth, M&T could still have room to run.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
Yelp, you're about to get a bad review
Apparently, social media insanity isn't dead after all! Yelp (NYSE:YELP), the web-based company that helps people find places to eat and shop, while also providing helpful user reviews, jumped by double digits yesterday to an all-time high, despite no company-specific news. There are reasons for investors to be impressed with Yelp's growth, given that its average monthly unique users rose 43% year over year, to 102 million, while net revenue jumped 68%. But, right about there is where all hope should cease and reason should set in.
Yelp is losing money, and I suspect it will continue losing money, or be unable to turn a sizable enough profit to command even half of this valuation, for quite some time. The reason Yelp isn't a smart investment is because a vast majority of its revenue is based on advertising (around 90%). It's very difficult to grow an aspect of your business that you have little control over. Even if Yelp successfully grows the mobile side of its business, the imminent paring back of QE3 should slow enterprise activity enough that advertisers will be affected by slower growth. Furthermore, every gain Yelp makes is countered by an expansion of its workforce or increased R&D, which creates a zero-sum game whereby the company cannot get ahead.
Yelp's also about to deal with an 800-lb. gorilla of a competitor, Google. Two weeks ago Google added a carousel feature to the top of its search pages for restaurants and bars, which works with its Google Maps function, in direct competition to Yelp's search function. Google has far better financial backing than Yelp, making it easier than ever for me to suggest avoiding Yelp.
Another company that makes a lot of sense on paper, and potentially over the long run, but looks like an imminent disaster over the interim, is social photo sharing and design company Shutterfly (NASDAQ:SFLY). It's benefited from a number of factors over the past couple of years, including the demise of Eastman Kodak, which allowed Shutterfly to acquire Kodak's personalized photo-based platform, and the increased digitization of consumers' lives. However, not all is as cheery as Shutterfly's premium valuation would imply.
The first thing that gives me cause for concern is Shutterfly's highly cyclical business. Typically, Shutterfly loses money in three of four quarters during a given year. That places a lot of pressure on Shutterfly and its management team to perform during the fourth quarter. If things don't go as planned, the share price can see a huge haircut.
Another often-forgotten factor is that consumer spending has almost all bearing on Shutterfly's prospects, because it accounts for more than 95% of all revenue. This year, we've seen higher payroll taxes eat into consumers' take-home pay, and we could be on the precipice of higher interest rates curbing enterprise expansion activity. These are all reasons to assume that Shutterfly's growth rate will fall from the current expectation of 20% this year.
Finally, this is a simple case of valuation. Cyclical companies, like Shutterfly, which more or less perform in-line with the economy, shouldn't be valued at 79 times forward earnings – not even in a scenario where the U.S. is growing by 5%... which it's not! Shutterfly has been expanding recently via small acquisitions, as well, serving to mask a slower organic growth rate than the reported top-line figure. In reality, I would suggest Shutterfly is worth about half of where it's trading today.
A crown of thorns
Media and broadcasting stocks are going through the roof lately as pricing power has improved, and the ongoing low-lending environment has allowed many to restructure their debt to much lower levels. I may not fully agree with the amount that some of these broadcasters' shares are gaining, but at least there's a fundamental reason behind the move. The same simply cannot be said for Crown Media Holdings (NASDAQ:CRWN).
Shares in the owner of the Hallmark channel have soared by 38% over the past four trading sessions as speculation builds that its subsidiary, Hallmark, which owns a 90% stake in the company, may opt to purchase it and take it private. Although I understand the move higher in shares, the truth of the matter is it's unjustified based on the historical underperformance of the Hallmark channel.
The biggest boost to Crown's bottom line was a 7% decrease in programming costs, which it said is likely to increase in the immediate future. Actual advertising revenue for the company only increased 2% in the latest quarter, signaling to me that it doesn't have any prime shows to attract big advertising dollars or viewers.
Like the previous two stocks, valuation is also a big concern. Crown Media is valued at 30 times cash flow, and boasts $450 million in net debt, while bringing in just $29 million in positive free cash flow last year. This doesn't give Crown Media much flexibility should it want to make an acquisition or negotiate new deals.
This week, it was all about three companies which gave speculators an inch -- and they stretched it a mile. Yelp, Shutterfly, and Crown Media are all valued with perfection in mind, when too many risks are present that could knock them off their perches.
Fool contributor 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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