The broad-based S&P 500 (^GSPC -0.60%) finished 2013 exactly as it began, on a high note with yet another record close, pushing the index up 30% for the year and sending 819 companies to a new 52-week high compared to just 71 new lows. 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 diversified energy company ONEOK (OKE -0.42%), for example. ONEOK lifted to a 52-week high in December after the Kansas Corporation Commission approved a settlement that would allow the company to spin off its utility operations from its other energy businesses. Spin-offs have been a serious driver of capital appreciation in recent years because they make revenue and earnings per share easier to understand for investors. Compound this move with the fact that natural-gas inventories have been falling, which is boosting natural-gas prices and the desire to recover natural gas from shale deposits, and you have the perfect recipe for continued success at ONEOK.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
A broken branch
Like many companies in 2013, Tree.com (TREE -5.12%), the lending advisory service for mortgage and nonmortgage loans, had an exemplary year, basically doubling its share price. Historically low lending rates have fueled interest in home purchases, pushing Tree.com's mortgage marketing products business to a new record as of the third quarter, with revenue in this segment up 73% from the previous year.
While I'll give credit where credit is due, I'm also well aware that the market doesn't care too much about what you've done for me lately so much as what are you going to do for me next week and the many weeks thereafter. On that front, I believe Tree.com faces a couple of rough years in its immediate future.
The majority of Tree.com's revenue comes from its mortgage marketing and advisory operations -- 87.4% of its business to be exact -- which means that it's incredibly sensitive to interest rate changes. With the Federal Reserve announcing in December that it plans to begin tapering its monthly bond-buying plan this month, it seems very plausible that long-term interest rates may rise. Since bond prices and yields have an inverse relationship, purchasing fewer bonds could lead to higher yields, and thus higher interest and mortgage rates (part of the Fed's bond-buying includes long-term U.S. Treasuries).
Weekly mortgage data from the Mortgage Bankers Association last week showed that U.S. home mortgage applications are at a 13-year low and are now down more than 60% since their May peak, even with 30-year mortgage rates up roughly 1% from their all-time lows. In other words, spoiled consumers are sitting on their hands despite rates that are still near a record low. If consumers are this fickle now, imagine what'll happen when rates return to their historical average as the Fed tapers even more of its monthly $85 billion stimulus.
With 2014 looking rough for the mortgage service market, I'd keep my nose clear of Tree.com his year.
A not so Greatbatch
Continuing with our theme of strong performers in 2013, we have medical device and orthopedics device maker Greatbatch (NYSE: GB).
As noted in the company's most recent quarterly report, Greatbatch delivered its fourth consecutive quarter-over-quarter improvement in gross margin as it managed to trim $10 million in operating expenses and bump adjusted EPS higher by 22%. An 11% increase in orthopedic revenue was also a big boost to Greatbatch's top-line results. Aging baby boomers in the U.S. could drive increasing demand for implantable and orthopedic devices, which on paper places Greatbatch in the driver's seat.
So why am I not a fan then, you might wonder? Two factors, in particular, concern me.
First, there's the implementation of Obamacare. Last year, Greatbatch and every other medical device company began paying a 2.3% medical device excise tax off their top-line revenue figure. As if this fee weren't enough, uncertainties surrounding Obamacare's implementation and whether enough young adults will sign up to offset the higher costs of insuring patients with pre-existing conditions could cause insurers and hospitals to temper spending on medical devices, where applicable, across the board.
The other concern here would be the unsustainable appreciation of its share price given Greatbatch's middling organic growth rate. The third quarter was right on target with 5% constant-currency organic growth, but looking ahead, we're likely to see this organic growth dip to just 3%. While not horrible, that type of growth rate isn't indicative of a company valued at nearly 20 times forward earnings. In addition, cost-cutting can only take Greatbatch so far, as we saw in 2013.
With no dividend to entice income-seekers and weaker top-line growth projections, I'd suggest sticking to the sidelines until we see a sizable pullback.
Hit the brakes!
Strength in the auto market over the past two years has been undeniable, with the U.S. market on pace to deliver more than 16 million vehicles on a seasonally adjusted basis since 2007. That's great news for new car dealerships and automakers, but it's not as good as you might expect for auto repair and maintenance shops like Monro Muffler Brake (MNRO -1.44%).
On the surface, everything appears fine with revenue growth in the double digits over the previous year, gross margin inching higher, and net income rising by 18% as of its second-quarter report for fiscal 2014. However, get this stock on the lift and look underneath and it's a completely different story.
Monro Muffler Brake's second-quarter report also revealed that all sales gains were due to the opening of new stores and acquisition of other stores. Monro's same-store sales (which exclude recently opened and acquired stores), actually fell 2.1%! While exhaust and brake sales rose, comparable-store sales for maintenance, alignments, and tires, some of its beefiest margin categories, fell 2%, 4%, and 6%, respectively.
Shareholders should really be concerned about what happens to Monro now that new auto sales are peaking. Today's vehicles are affordable, fuel-efficient, and designed to last well in excess of 200,000 miles. They usually come with extended warranty packages. In other words, outside of vehicle modifications (i.e., exhaust), where's Monro's opportunity to boost business with better-built cars out on the road?
I personally believe there's little chance Monro can hold the line at 26 times forward earnings and with negative same-store sales comparisons. Look for this company to stall out in the fast lane.