Corporate revenue growth may still be weak, and the housing sector may lean every time interest rates so much as hiccup 0.125% higher, but with the CBOE Volatility Index traipsing along near multiyear lows, is seems as if nothing can stop the broad-based S&P 500 from heading even 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 valuations. Take Wells Fargo (NYSE:WFC), which hit an all-time high earlier this week. Most banks have been mired in scandal and are still dealing with the ramifications of the mortgage meltdown from the housing bubble collapse. Wells Fargo, however, has largely avoided the settlement headlines, the bank's main tenets of growth rely on increasing deposits and generating loan-based income. Given that it has a significantly higher return on assets than other money-center banks, and remains adored by billionaire investor Warren Buffett, there's hardly any reason to consider selling Wells Fargo.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
Clip this coupon
There's no doubting the fact that we as a society like to save money. LivingSocial and Groupon are testaments to the fact that coupons and promotional events can draw traffic to a company. Of course, it's up to a business's products or service to keep drawing customers back, because promotions alone won't drive a business forever. In this context, I simply can't overlook the egregious valuation being placed on recent IPO Coupons.com (UNKNOWN:COUP.DL) and believe investors may want to consider clipping their gains here while they have the chance.
As with most dot-coms, there is plenty of top-line growth to be had here. Coupons.com's first quarter delivered a 41% increase in revenue to $51.5 million as the number of transactions surged 30% year over year to 407.8 million. Adjusted EBITDA also jumped 180% to $3.9 million as Coupons.com generated $0.9 million in positive free cash flow.
These are good numbers, and I wouldn't take anything away from Coupons.com shareholders -- if its stock price was still south of $20 per share. However, with shares touching higher than $30 this week I have to sound the alarm on a number of key statistics.
Perhaps the most alarming trend here is that Coupons.com's gross margin has not grown alongside its top line. Between 2011 and 2013, the margin stayed consistent in the high 60% range, yet the company has been unable to deliver generally accepted accounting principles profits. Its latest quarter saw Coupons.com's GAAP loss widen 70% to $14 million. It's always disconcerting when a company with such low input costs consistently has difficulty turning a profit.
Another major concern is the weak barrier to entry in the digital coupons sector. Although few companies can match the digital coupon channel that Coupons.com has built, the actual costs to enter the sector are relatively low. This means that over the long term Coupons.com's pricing power is more likely to erode than to increase.
With Coupons.com valued at nearly 90 times forward earnings and better than 10 times sales, it looks like this company is the one that needs a discount to attract future buyers.
Skip this breakfast
Tony the Tiger may be one of the most recognizable breakfast cereal characters in Kellogg's (NYSE:K) product portfolio, but things aren't as "grrrrrrrrrreat" as they appear.
Similar to Coupons.com, Kellogg sports features that have made it appealing to select optimists. Perhaps nothing is more attractive than the Kellogg brand name itself. The company owns a myriad of brand-name products in the breakfast, dessert, and snack spaces. These brands are household names that practically sell themselves, meaning that Kellogg's sales and cash flow are often very predictable -- and Wall Street loves predictability.
Another factor boosting Kellogg is the fact that it reaffirmed its full-year guidance in the first quarter. Kellogg has been working to persuade consumers to try its breakfast products at times beyond traditional breakfast hours, and based on its earning-per-share reaffirmation it would appear that its efforts are working to some extent.
So what's not to like? My biggest beef (or should I say flake?) with Kellogg is that its peers are seeing immense growth opportunities in the breakfast segment, and consolidation among food producers could put pricing and marketing pressure on Kellogg's breakfast operations as a whole. I believe we're already beginning to see these pressures, with Kellogg's first-quarter net sales down 3.1%. Further breaking down this figure, internal net sales in North America dipped 2.4% and international sales from the Asia-Pacific and Latin America shrank 10.7% and 9.8%, respectively. How Kellogg has failed to grow in two of the fastest-rising emerging markets is beyond me, but it's a big red flag.
Another concern is that stable food costs are rarely stable for long periods of time. Food costs tend to be cyclical, and when they begin to rise again Kellogg's forward P/E of 16 and sales growth rate of less than 2% are going to look downright ugly.
Ultimately, Kellogg is a fantastic brand-name food producer, but at this valuation it's looking a bit soggy.
I spy with my little eye something that is overvalued
I'm going to end this article exactly as I began it: by picking on a relatively recent IPO, except this time it's from the biotech sector. Everyone take a good long look at Applied Genetic Technologies (NASDAQ:AGTC), or AGTC as it prefers to be known, because it could be set to provide short-sellers with an intriguing opportunity.
Like most clinical-stage biopharmaceutical companies, AGTC on paper offers investors a promising story. The company is focused on developing gene therapies to inherited orphan eye diseases; it has three ophthalmic-based programs in development, in addition to a gene therapy targeted at AAT deficiency, a rare type of lung disease that can lead to chronic inflammation of the lungs.
However, this 14-employee operation is now approaching a $300 million valuation even though only two of its six developing programs have even reached clinical stage. AGTC only expects to begin the phase 2b portion of its AAT deficiency study by early 2015, while its proof-of-concept ophthalmic study LCA2 will only enter phase 1/2 studies by late 2014. The not-so-subtle translation of AGTC's pipeline is that investors are placing almost all of their hope on drugs that are still largely going through animal studies. Given how many preclinical drugs fail in clinical trials it looks as if investors are counting their chickens before they're hatched.
The other concern here would be ongoing losses while AGTC develops its pipeline. AGTC ended its latest quarter with $24.5 million in cash and cash equivalents, as well as $51.8 million from its IPO. Although this cash comprises more than a quarter of the company's current valuation, its costs are only expected to rise as it moves beyond animal studies and begins to register its ophthalmic products for clinical trials. With an expected run-rate loss near $16 million in 2014, and my projection that this will increase to more than $20 million in 2015, it's quite possible we could see a dilutive stock offering if shares continue to move higher.
I suggest biotech investors stick to the sidelines here until there is later-stage data that we can wrap our hands around. Before that point I'd consider this a very risky investment.
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 Wells Fargo and has the following options: short June 2014 $50 calls on Wells Fargo and short June 2014 $48 puts on Wells Fargo. 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.