U.S. economic data continues to be mixed at best, yet earnings strength, highlighted by plenty of cost-cuts and share buyback-induced beats, keeps pumping the broad-based S&P 500 higher. 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 the Dow Jones Industrial Average's most loved stock, General Electric (NYSE:GE). About three weeks ago the highly diversified GE reported a record level of backlog, with order growth of 18% domestically and a surprising 17% in Europe. With the company catering to the high-growth energy and health-care industries, which have demonstrated a nearly insatiable demand over the past decade, I'd postulate GE could be in line for continued gains moving forward.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
A clouded future
With cost-cutting and operational efficiency being the name of the game for most tech companies in this uncertain growth environment, companies like Datawatch (NASDAQ:DWCH), which provides information optimization for enterprise networks, are thriving.
Datawatch has benefited from a push toward big-data centers, which are costlier up-front ventures that improve costs and business performance over the long term. In addition, Datawatch has forged multiple partnerships that should help fuel product sales, including one to provide integrated content management solutions for IBM's Content Manager OnDemand.
However, Datawatch is lacking one crucial component that I feel makes the company a strong sell candidate after running higher by more than 200% from its 52-week lows: its lack of sales growth. I would consider giving Datawatch the benefit of the doubt had its revenue growth been strong, but as of its most recent quarter growth was a meager 4% year over year. This is worrisome because most data center-focused solutions providers are delivering double-digit growth, and Datawatch has a much smaller research and development budget than many of its competitors.
Datawatch is presently valued at some 300 times next year's earnings, about 22 times its book value and 65 times cash flow. It would take a monstrous contract or one heck of an earnings beat in its third-quarter release later this month to justify that valuation. I would consider taking this month's gains as a gift and exiting while the getting is good!
A parabolic problem
It has also been a year to remember for shareholders of biopharmaceutical company Gentium (UNKNOWN:UNKNOWN) whose share price has catapulted approximately 600% off its lows thanks to growth in its lead drug Defibrotide (known as Defitelio in the European Union).
Targeted at treating severe hepatic veno-occlusive disease, and possibly lined up to receive a secondary indication to treat acute graft versus host disease in the EU, peak sales estimates for Gentium's lead drug have vacillated around $400 million assuming multiple indications. In its most recent quarter, Gentium reported a 41% increase in Defibrotide revenue over the previous nine months, to $32.7 million. In other words, the drug is selling well, and I will certainly give optimists that point of contention.
However, extrapolating its sales growth outward, Gentium is valued at roughly 17 times current sales and it assumes that Defibrotide can grow without any competition or hiccups, which is rarely the case in the biotech sector. At roughly two times peak sales estimates, many investors would contend that Gentium could have further room to run, but I would respond that this would be the case only if it gains these crucial additional indications, and if physicians continue to increase the use of Defibrotide. With a near-hyperbolic rise in Gentium's share price over the last couple months it could be a smart idea for investors to take some or all of their money off the table here and let the company's top-line results catch up with its current valuation.
Last, but certainly not least, we have Globalstar (NYSEMKT:GSAT), a service provider of voice and data over satellite networks. I rarely delve into over-the-counter CAPS recommendations, but with a $1.1 billion valuation this is one company I regard as egregiously overvalued that investors may want to avoid
The impetus for Globalstar's more than 500% run since its 52-week lows relates to the Federal Communications Commission's recent decision to consider allowing the company to offer its mobile services over existing satellite networks. The move wouldn't be unprecedented, as DISH Network last year won the right to offer mobile services over satellite networks that had previously been utilized just for satellite services.
I would contend that buying into this theory could be a very bad idea. Globalstar hasn't turned a full-year profit since 2006. Furthermore, it's been diluting the heck out of shareholders in order to generate cash for ongoing operations. Since 2006 the count of outstanding shares has ballooned from 64 million to 446 million! This is the antithesis of a healthy company. Even if a suitor were interested in its spectrum, it would also be taking on $706 million in Globalstar's net debt.
Without speculating on how the FCC will rule, I strongly suggest that if you own it or have considered buying, you should look elsewhere for investment ideas.
This week's theme was discovering that big gains sometimes come in small packages, but that those gains are sometimes a bit overzealous due to emotional investing. Datawatch's tepid growth rate, Gentium's tame Defibrotide sales, and Globalstar's atrocious track record would make all three of these companies strong sale candidates in my book.
Editor's note: This article has been modified from its original version to better address Globalstar's FCC decision.
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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