The broad-based S&P 500 has given up ground in 11 of the past 15 sessions due to worries over a protracted government shutdown and a looming debt ceiling debate. However, if you were to run a screen of stocks within 10% of a new 52-week high in The Motley Fool CAPS Screener database, you'd see that nearly 44% fit that criterion. 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. Southwest Airlines (LUV -0.84%), for instance, is flying the friendly skies to a new 52-week high after reporting earlier this week that passenger revenue per available seat mile rose an estimated 7% to 8% for September. Southwest has been able to thrive in light of stiff competition thanks to its focus on underutilized metropolitan routes and relying minimally on baggage fees to pad its pockets. With a dividend yield now above 1% (no small feat for an airline) and 40 consecutive years of profits, we should be taking Southwest's success very seriously.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
All your eggs in one basket
Within the biotech sector, placing all of your eggs in one basket can be a dicey and risky proposition. For some companies, it's worked out great such as Alexion Pharmaceuticals, whose Soliris has turned into a blockbuster drug. For others, it's been a veritable nightmare, such as Affymax, which was obliterated earlier this year when its lone FDA-approved anemia drug, Omontys, was pulled from pharmacy shelves because of rare cases of anaphylaxis and three deaths. Therefore, when I weigh single-drug pipelines, I often err on the side of caution, which is not what Kythera Biopharmaceuticals (NASDAQ: KYTH) investors are currently doing.
Kythera actually has a rather intriguing drug (its only drug in clinical development, mind you!) in ATX-101, a treatment for submental (under the chin) fat. In other words, Kythera has been developing a drug for the past six years to rid people of double chins. In late-stage trials, ATX-101 met its primary endpoint and looks poised to work its way before the Food and Drug Administration sometime next year. I would, however, remind investors to exercise a good degree of caution moving forward with the stock having nearly doubled since late August.
To begin with, even if ATX-101 is approved, the ramp up of production and sales isn't going to get the company to profitability anytime soon. With that being said, just two days ago Kythera announced a whopping $120 million secondary stock offering in order to raise cash for a proposed drug launch. In the meantime, existing shareholders get diluted while the company is on pace to burn through about $55 million in cash this year and another $38 million in 2014 by my best guess.
Another concern few have discussed would be the insurance aspects of such a medication. Few insurers under the new Obamacare health insurance plans cover cosmetic procedures and drugs, which could hurt Kythera's chances of maximizing sales.
Finally, no drug approval is a guarantee in the biotech sector and neither is a successful drug launch. The current valuation of $820 million for Kythera assumes an approval and a rapid acceptance of ATX-101. As for me, I see plenty of potential stumbling blocks and would suggest keeping your distance at these levels.
Betting big on early stage results
I'm not strictly trying to pick on the biotech sector this week, but the recent explosion in share prices for early-stage results has been nothing short of scary. This week, I'll be highlighting TherapeuticsMD (TXMD -0.54%), which is a developer of vitamins for female health care and a clinical-stage biopharmaceutical company focused on developing hormonal therapies to treat menopause.
As it relates to the company's over-the-counter vitamin and cosmetic products, I see nothing but success. Through the first six months of the year, revenue is up 135% while costs rose a measly 20% as the company expanded into new territories and brought on a larger sales staff. The problem is that these products accounted for just $3.6 million in sales over this time period and TherapeuticsMD is pushing a half-billion dollar valuation!
What has the market really excited is its investigational trio of bio-identical hormonal therapies designed to treat menopause in women. Just yesterday TherapeuticsMD reported positive phase 1 results from a 66 patient trial for TX 12-001-HR, which is a capsule that contains the hormones estradiol and progesterone. Although the results appear encouraging, the company must now undertake enrollment in a 12-month study of 1,550 patients. Just think about the costs associated with this study (and did I mention they plan to run three phase 3 studies this year?) and the fact that only about 10% of phase 1 drugs succeed in phase studies.
Cash burn would be another serious concern. TherapeuticsMD, just like Kythera, offered 13.75 million shares last month, raising an estimated $33 million, which will be added to the $34 million it had on its balance sheet as of last quarter. With the company burning through what I estimate is $25 million in cash each year, it has less than three years of cash left even following its offering. Translation: Expect more dilutive offerings in 2014.
I've said it before, and I'll say it again: Wait for late-stage data so you have something tangible to trade on instead of chasing after what could be fruitless early-stage gains.
Betting on a return to common sense
The past couple of months have also delivered a really odd trend among Chinese small caps. Whereas this group of stocks had been absolutely off-limits since more than a dozen accounting frauds were uncovered in 2010 and 2011, Chinese small-cap stocks have been shooting up on a regular basis lately on practically no news. Because of this, the Guggenheim China Small Cap ETF (HAO) has practically jumped back to a new 52-week high. But can it last? I doubt it.
Taking a quick look at the Guggenheim China Small Cap ETF and you'll first be smacked in the face by what I deem to be a pretty high net expense ratio of 0.75%. To add, the company's profile targets Chinese-based companies between $200 million and $1.5 billion in market value, effectively chasing growth but removing any stabilizing factors in an already volatile region.
This ETF's largest holding is Youku Tudou (NYSE: YOKU), an Internet television platform in China that's growing like wildfire but still can't turn a profit. Sales are expected to grow by 71% this year alone at Youku Tudou, but EPS losses are expected to total a whopping $2.58 this year. Furthermore, Youku Tudou has missed Wall Street's EPS estimates in five of the past seven comparable quarters -- and that's this funds' largest holding!
There are far too many variables here that could affect Chinese small-cap stock growth such as China's slowing GDP growth rate and even the government shutdown and debt ceiling debate in the United States. With that being said, I'd suggest caution around Chinese small caps and ETFs and to keep your distance from this one.
Foolish roundup
This week's theme was as simple as "show me the results!" In all three stocks this week, it looks as if we've got investors counting their chickens long before they've hatched, which often doesn't work out well for 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?
