While yesterday put an end to the S&P 500's five-day winning streak, the broad-based index was able to knock off multiple new all-time closing highs before the drop, as the government ended and the debt-ceiling crisis was averted for the time being. 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. Take specialty glass and materials company Corning (NYSE:GLW) as a perfect example. Yesterday the company announced solid preliminary third-quarter results that topped the consensus earnings per share by $0.01. In addition, Corning forged a deal to buy Samsung's remaining 43% stake in Samsung Corning Precision Materials, a joint venture in Korea that makes glass substrates like Gorilla Glass that are used in LCD television and mobile devices including smartphones and tablets. Gorilla Glass is Corning's most exciting product and easily offers it the best chance for rapid growth. With this deal, Corning will now derive all of the revenue from Gorilla Glass sales, making the company a potentially inexpensive play at just 13 times next year's earnings.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
Flight of the Phoenix
Sometimes when a company soars after an earnings report, it just leaves you scratching your head. That's exactly what happened following the Tuesday evening release of for-profit educator Apollo Group's (NASDAQ:APOL) fourth-quarter results.
On paper it was a pretty good quarter relative to what Wall Street had forecast. Apollo, the parent company of the University of Phoenix, delivered $845 million in revenue and a profit of $0.55 per share which was modestly higher than the $0.46 in EPS it reported in the year-ago period. Comparatively, Wall Street expected just $0.25 in EPS and revenue of $823 million.
But if you look past this headline figure, there wasn't much to cheer about. Overall revenue sank 15% to that $845 million figure as enrollment at the University of Phoenix was down 18.1% over the year-ago period. Things got even worse when Apollo issued its fiscal 2014 forecast, which called for revenue of just $2.95 billion-$3.05 billion. That's much lower than the $3.2 billion the Street had forecast, and well below the $3.7 billion and $4.3 billion in revenue it brought in for fiscal 2013 and 2012. In other words, the ship just keeps sinking!
The only saving grace for Apollo has been its cost reductions. For fiscal 2014 the company notes that it plans to reduce operating expenses by another $300 million. Unfortunately, cost-cutting can only drive earnings so far, and heavy industry regulations and the lack of organic growth are becoming quite evident in its results. My suggestion would be not to get suckered in by yesterday's rally and stick to the sidelines until Apollo demonstrates organic enrollment growth once again.
Fool me once, shame on you -- fool me twice...
It's as if investors didn't learn their lesson or didn't get burned badly enough by social-media giant Zynga (NASDAQ:ZNGA) that they've decided to come back and try again with China Mobile Games and Entertainment (UNKNOWN:CMGE.DL).
I'll give China Mobile Games credit where credit is due. The company, which develops a wide array of social-media games in China and earns its revenue through subscriptions to select games, finished its most recent quarter with 1.4 million paying customers, up from just 158,795 paying accounts at this time last year. As such, revenue rose 19% from the second quarter in 2012 and about 97% from its sequential first-quarter sales. But the praise stops there.
One of the primary detriments to social-media gaming is that the user base is fickle and it's practically impossible to get users to pay for what can be found free almost anywhere. China Mobile Games is obviously doing something right if it has 1.4 million paying customers, but a more telling figure is its average revenue per user, or ARPU. ARPU is a margin measure that allows us to see whether consumers are spending more or less with the company. In this case, social-media gaming ARPU fell to just $3.43 in the latest quarter compared to $12.42 in the year-ago period. That's bad news and means consumers are spending far less than before on social media games. Zynga went through similar growing pains in which subscriber count rose but the number of paying customers simply didn't budge.
Another key factor working against China Mobile Games, other than its ongoing losses, is that it's downright impossible for game developers to have a hit each and every time. This was Zynga's primary downfall. It expected every game would be successful following FarmVille, and that wasn't the case. So what we're looking at with China Mobile Games is a nonprofitable social media game developer that has growing subscribership but falling ARPU, and that'll need constant hits in order to turn a profit. If Zynga showed us anything it's that social gaming loyalty is fleeting. I'd consider taking the recent run-up China Mobile Games has given shareholders and hit the exits!
XL price, XS potential
Last, but certainly not least, we'll take a closer look at Destination XL Group (NASDAQ:DXLG)a specialty retailer of big and tall men's apparel in the U.S., Canada, and England.
As with the previous companies we've admonished, there are positives to be seen in Destination XL -- primarily in that it operates in a niche space. Sure, you may see department stores devoting a small section to big and tall men, but for the most part Destination XL is one of the few stops for XL-sized gentlemen. That alone gives it some degree of pricing power and inventory control that its peers rarely have on a consistent basis.
However, if Destination XL has this control, I certainly haven't seen it in recent months. Destination XL has missed Wall Street's expectations in three of the past four quarters, lowering its full-year forecast to a loss of $0.03 to $0.05 per share in its most recent quarter and scaling back the rate of new store openings. The company is doing what it can to reduce costs by cutting back on the number of catalogs printed in the fall but, again, slashing expenses only goes so far when there really isn't any organic growth.
In all fairness, it's been a miserable past three months for retailers and this could be a difficult holiday season. While Destination XL has the tools to turn around its business, a lack of organic growth coupled with a forward P/E of 51 is way too much to overcome when it's consistently missing Wall Street estimates.
This week's theme is all about looking beyond the headline numbers. Sure, revenue growth at China Mobile Games and EPS at Apollo Group are topping expectations, but beyond that headline number there are disturbing red flags below the surface. Likewise with Destination XL, we have a company with a well-defined niche but absolutely no organic growth follow-through.
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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