The broad-based S&P 500 may be nearly 4% off of its all-time highs set just a hair over two weeks ago, but you certainly wouldn't know it by the more than 2,100 stocks in the Motley Fool CAPS database that are trading within 10% or less 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. Big-box retailer Best Buy (NYSE:BBY) had essentially been written off for dead because of online competition, but a shuffled strategy that focuses on mobile, traffic-driving products, price-matching, and cost-cutting, has ignited profits. Earlier this week, Best Buy delivered a $0.32 per share profit compared with expectations of just $0.12. That's easily worth a new 52-week high if not more!
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
Selling at the Lowe's
Despite having been beaten in almost every metric by Home Depot since the recession, Lowe's (NYSE:LOW) shares are on fire, fueled by a strong rebound in housing that, in turn, has been promoted by historically low lending rates. Whether people are furnishing a new home or merely remodeling an existing one, the cost of a loan to finance such an activity has rarely ever been lower than it is now, which is great news for the home-improvement sector.
Yesterday, Lowe's reported what Wall Street would deem a fantastic quarter. The company delivered a 10% increase in sales to $15.7 billion and EPS of $0.88. The Street, on the other hand, was looking for a modest profit of $0.79 per share on $15.1 billion in sales. It may seem like these home improvement stores are having trouble keeping up with demand, but Lowe's is actually a lot more fragile than it might appear on the surface.
My big worry with Lowe's has always been its reliance on appliance sales to really drive margin expansion. Lowe's has done a decent job cutting costs and promoting its direct-to-consumer sales (perhaps the one edge I'd give it relative to Home Depot), but it's still more intricately tied to the health of the homebuilding sector than Home Depot because of its appliance-heavy product portfolio. This is troublesome, because lending rates are at their highest levels in almost two years, and that could cause a quick paring back in consumer spending for homeowners who've been spoiled for years with ever-lowering interest rates. When the Federal Reserve does finally begin winding down QE3, that will also negatively affect home-improvement purchases.
At roughly 18 times forward earnings for Lowe's, the pitfalls appear to outweigh the reward here, and I'm going to flip my CAPScall to underperform from outperform.
Too many hops
I don't know about you, but I consider myself to be somewhat of a beer snob/connoisseur. You know those people who take notes on all of the different beers they drink? Yeah, that's me! With that being said, you'd think I'd be a supporter of Craft Brew Alliance (NASDAQ:BREW), which is made up of the Widmer Brothers, Kona, Omission, and Redhook brands -- but that's not the case.
Net sales for the most recent quarter grew by 10.7%, but when we strip out recently introduced beers, the true year-over-year organic growth level drops to just 3.4%. Introducing new beers isn't a bad thing, and it certainly helps keep beer enthusiasts who have insatiable palates occupied, but 3.4% organic growth doesn't go nearly far enough to explain why this company is valued at 41 times next year's earnings projections.
Year to date, lower capacity utilization has also hurt Craft Brew Alliance, resulting in gross margins that are down 240 basis points from this time last year. This leads me to question whether we are about to see a glut of craft brewers sour the market. According to the Brewers Association, the number of breweries in the U.S. has jumped from just 89 to more than 2,500 in approximately 35 years. I believe that's far, far too much beer capacity to meet demand and would bet on industrywide weakness until production as a whole slows or industry consolidation occurs. With an already hefty valuation, I think you can easily leave this beer on the shelf.
Sometimes you feel like a nut, sometimes you don't
It's certainly been a long road for walnut producer Diamond Foods (UNKNOWN:DMND.DL), which has put shareholders through the wringer after it was probed for making improper payments to walnut growers in 2010 and 2011.
But things are completely different now that the company is more than a year removed from its initial investigation. According to a company press release, it has settled on a shareholder lawsuit for $96 million, to be paid with $11 million in cash and 4.45 million shares in stock, and boosted its fourth-quarter sales outlook to a range of $196 million to $201 million from the current consensus of $187 million. Yet I'd still take pause at these results and use yesterday's big spike as all the more reason to sell and not look back.
To begin with, there's the PR damage caused by Diamond Foods' walnut scandal, which is going to make future deals tough to come by, and cost it them the chance at diversifying their product lineup by purchasing the Pringles brand from Procter & Gamble. Instead, Kellogg (NYSE:K) swooped in once Diamond Foods' situation deteriorated and scooped up the Pringles brand from P&G for $2.7 billion, and it has been reaping the overseas rewards of this purchase ever since. It takes just a few bad acts to spoil a company's reputation, and it could be quite a while before Diamond Foods' previous buyers and investors are willing to give it a second chance.
As my Foolish colleague Travis Hoium also pointed out yesterday, Diamond Foods is leveraged to the hilt. The company ended last quarter with a debt-to-equity of 189% and plans to finance its settlement by releasing 4.45 million shares. In other words, it's going to increase its share count by 20% and dilute existing shareholders just to take care of wronging previous shareholders. To me, it sounds like more of the same for Diamond Foods.
Until we see strong signs of profitability and a meaningful reduction in debt, I think this is a company investors should avoid.
This week's theme for all three companies is all about looking past a few decent earnings reports and seeing a history of underperformance in relation to their peers. Lowe's reliance on appliance sales, a potential glut of craft beer for Craft Brew, and a dilutive share offering for Diamond Foods are all the more reason to send these three stocks to the sale rack.
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.
The Motley Fool recommends Home Depot, Lowe's, and Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.