Stock market correction, it's like we hardly even knew you! After dipping more than 100 points below its all-time closing high, the broad-based S&P 500 has now galloped higher in four of the past five trading sessions and is once again within striking distance of a new record 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. You might call me crazy, but take Green Mountain Coffee Roasters (UNKNOWN:GMCR.DL) as a prime example. The company struck a 10-year deal with Coca-Cola last week to bring Coke's product into users' homes beginning in 2015 on its Keurig Cold machine -- that was on top of a 26% gain in adjusted EPS in the fourth-quarter. Green Mountain has an abundance of top-tier partnerships now in place, and the long-term Coke partnership, as well as its fresh 10% stake in the company, could yield an easier path for Green Mountain to get its products into Europe.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
For most of the companies that appear on this list, there's a very good reason they've vaulted to a new 52-week high (or near one). In this case, for biotechnology juggernaut Alexion Pharmaceuticals (NASDAQ:ALXN) it's the performance of its only FDA-approved drug, Soliris.
Soliris, the most expensive drug in the world, delivered a 38% increase in sales in the fourth-quarter, with Alexion now forecasting a midpoint of $2.01 billion in sales in the upcoming year. Alexion thrives off of the fact that it treats ultra-rare diseases, leaving its drug free of competition and giving it a justifiable reason to charge a high price for its drug. The end result was a much better than expected profit forecast of $3.70-$3.80 in 2014 versus the Street's original consensus estimate of $3.42.
Despite the solid results, I'm in no way sold on Alexion here. One of the factors that always made Alexion attractive was the potential for a buyout. Rumors swirled last year that Roche may have been interested in purchasing Alexion for as much as $24 billion. With those rumors squashed and Alexion now valued at a whopping $34 billion, the possibility of a buyout seems to be practically nonexistent.
Another concern here is that practically all of Alexion's eggs are in one basket with Soliris. This can be a concern, as we saw Affymax get clobbered last year after its lone FDA-approved drug was pulled from the market because of safety concerns. There currently isn't any data demonstrating that Soliris isn't safe, but it isn't exactly comforting to know that if something were to go wrong with Soliris it would practically affect Alexion's entire pipeline.
Finally, we're talking about a frothy valuation here. Based on current projections, Alexion is valued at 17 times Soliris' 2014 sales, 14 times book value, and about 47 times this years' EPS projections. In other words, Alexion will need to execute perfectly moving forward if it hopes to keep its current valuation; and I just don't see that happening.
A failure to communicate
If I didn't know any better I'd suggest that shareholders in Cogent Communications (NASDAQ:CCOI), a supplier of high-speed Internet, Ethernet transport and colocation services to small and medium-sized businesses, had hit the lottery.
Over the past year shares of Cogent have risen about 75% with hardly a downtrend in sight. Even more impressive, Cogent shares have rallied since the summer of 2010 by better than 400%! There certainly have been signs of growth for the ISP, with the company increasing its service revenue by 10% in the third-quarter to $87.8 million as traffic nearly doubled from the year-ago quarter. Adjusted EBIDTA also advanced by 17% to $30.7 million.
In spite of this growth, I'm calling a failure to communicate here between Wall Street/investors and Cogent Communications. Cogent has widely missed profit expectations in each of the past four quarters, and for all intents and purposes is barely profitable. Its trailing P/E, which is currently above 500, is almost laughable, while its forward P/E of 94 is enough to scare all value investors away.
Now here's the thing: plenty of Internet and cloud-based companies are sporting really high P/E ratios, but they're also working with growth rates of 20%, 30%, or perhaps even more than 50%. Shareholders in Cogent are working with an astronomically high P/E with a sales growth rate of just 10%-11%. Historically smaller businesses are going to deliver premium growth rates, but it also makes Cogent more susceptible during economic downturns.
Unless we see Cogent's costs dip significantly or witness an expansion in its organic growth rate, there's little reason for investors to be excited about Cogent's current prospects.
Inciting me to sell
Rule numero uno of investing is not to fall in love with a stock -- and while I do like Incyte (NASDAQ:INCY), the company's numerous partnerships, and the solid growth of its myelofibrosis drug Jakafi, I simply can't see this valuation expanding any further with the company worth nearly $11 billion.
Incyte reported its fourth-quarter results before the opening bell yesterday, and generally speaking they were solid. Jakafi net product sales grew 68% in the U.S. to $72.9 million, and royalty revenue from its licensing partnership with Novartis (NYSE:NVS) for Jakavi (the EU version of Jakafi) more than doubled to $8.4 million. Unfortunately, contract revenue -- which is merely amortized milestone revenue -- dipped noticeably to just $15.8 million, and caused Incyte's year-over-year revenue to fall 15%.
There were clearly strong points to Incyte's guidance as well. The company now predicts net product sales from Jakafi of $315 million to $335 million in 2014, marking an expectation of 38% organic growth at the midpoint. However, hefty losses are expected to continue, with R&D expenses totaling $350 million to $370 million and selling, general, and administrative expenses rising to $145 million to $155 million. Long story short, investors have pushed Incyte to a valuation of close to 30 times its 2014 sales forecasts (including its contract revenue guidance) despite steep expected losses.
In order for me to support this valuation I'd need to see Jakafi sales of nearly $1 billion annually, which is where most analysts expect sales to peak. This scenario assumes no other drug approvals, which also seems unlikely. In another context, it simply means that Incyte may be worth $11 billion, but it could be two or three years ahead of where it should be.
This will be another transformative year for Incyte, with late-stage data from its RESPONSE and RELIEF trial for polycythemia vera due by the first-half and mid-2014 for Jakafi and results from its ongoing clinical study of bacritinib for rheumatoid arthritis with Eli Lilly expected later this year. If this data isn't picture-perfect, Incyte will likely find itself on the sale rack.
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 owns shares of, and recommends Coca-Cola. It also recommends Green Mountain Coffee Roasters. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.