Through Monday the S&P 500 had hit nine record closing highs within an 11-day trading period despite economic data showing worsening GDP and worker productivity in Q1 and a sharp increase in labor costs. 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 oil drilling equipment provider National Oilwell Varco (NYSE:NOV), which has delivered a number of recent catalysts for investors, including a 77% increase to its dividend to $0.46/quarter for a fresh yield of 2.4%, as well as the spinoff of NOW last week, which gives investors multiple ways to profit from the coming surge in demand for oil equipment services through either National Oilwell Varco's high-growth rig technology segment or its slower growing, but consistent, distribution spinoff. At a mere 11 times forward earnings, National Oilwell Varco could prove to be a steal for long-term investors even near a 52-week high.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
Do you "see" what I mean?
As I've mentioned a number of times during this bull market run, sometimes companies are a sell not because their business outlook is poor, but merely because emotional traders have grossly mispriced them based on their outlooks. The first company on this week's potential sell list is Ophthotech (NASDAQ:OPHT), a clinical-stage biopharmaceutical company developing drugs that'll treat diseases of the back of the eye.
On the surface, you can probably see why Ophthotech is performing as well as it is simply from its development focus. An aging population that's living longer likely means an increase in cases of wet age-related macular degeneration (wet-AMD) and other common eye diseases. Theoretically, that could mean a bounty of business over the long run if Ophthotech is able to bring either Fovista, its investigational anti-PDGF wet-AMD drug currently in phase 3 studies, or Zimura, its investigational anti-complement wet-AMD drug in phase 2 trials, to market.
The really big news, however, came from a collaborative deal announced roughly three weeks ago with Novartis (NYSE:NVS), which will allow Novartis to license Fovista in all countries outside the U.S. for an upfront fee of $200 million, as well as $130 million in near-term milestone enrollment payments and a combination of $700 million worth of ex-U.S. approvals and sales milestones. In other words, Ophthotech could net itself more than $1 billion in total milestone payments in a perfect world, and it's also removed any shred of doubt that it has enough cash on hand to conduct further research.
On the other hand, investors should consider that Fovista's phase 3 results aren't due until 2016. Compound this wait time with another 6- to 10-month review process from the Food and Drug Administration, and we're looking at a launch date of 2017, more than three years away. That's a long time to wait without any major catalysts, especially considering Ophthotech's ballooning valuation.
Another factor to consider here is that by 2017 it could become increasingly difficult to unseat Regeneron Pharmaceuticals and Bayer's Eylea, which is already a blockbuster. By 2017 Eylea could be producing worldwide sales of somewhere in the neighborhood of $2.5 billion by my estimates. If Fovista isn't markedly more effective than Eylea or priced accordingly, it may stand little chance of chipping away at Eylea's dominant market share by then.
My suggestion would be to cut Ophthotech loose here and keep it on your watchlist in case it has a sizable tumble which may once again make it worth your while.
So much for sleeping well at night
The second selection this week echoes many of the same points as the first: a decent company and overall concept, but a valuation that simply doesn't make sense. What might be really upsetting about this pick is that my suggestion just might throw the idea of you sleeping well at night out the window. This pick is none other than the world's largest bedding provider: Tempur Sealy (NYSE:TPX).
On one hand, Tempur-Pedic's acquisition of Sealy was a smart move in that it not only expanded its product line, but added a well-known brand-name and reputation to its product portfolio. Not to mention that having one less competitor in the bedding space should come in handy in reducing marketing expenses and eliminating distribution channels, which should add to synergy costs. Ultimately the deal should be profitable for the combined entity, which is all shareholders ever really ask for when one company buys another.
However, since announcing its intent to buy Sealy in late Sept. 2012, its shares have more than doubled, mostly on the prospects of improved branding, expected cost-savings, and strong profitability. What's flown under the radar, though, is a pretty consistent weakening in Tempur Sealy's operating margins, going from a robust 24% in 2011 to just 9.4% over the trailing 12-month period according to Morningstar. Weaker operating and gross margins means that Tempur Sealy needs to work harder to turn in the same profit as last year. What I believe we're witnessing is simply the ongoing growing pains of incorporating Sealy into the fold. Eventually I do expect margins to improve, but it's not going to be an overnight fix.
Also, if we remove Sealy from the equation and simply focus on Tempur-Pedic's growth, you'll see that the sheep aren't hopping the fence in unison with its share price. Overall Tempur-Pedic sales were down a tad more than 1% organically, with North American sales dipping close to 6% and international sales jumping 7%. With North American sales making up about 63% of total first quarter sales, the company will need to see a stabilization in this region if it hopes for any chance at a rebound.
Generally speaking, I wouldn't normally pick on a company trading at 17 times forward earnings with a growth rate in the mid-to-high single-digits -- but with its namesake brand drastically underperforming and cost synergies potentially years off, it might be wise for investors to sleep on the couch for a while.
Gotta get (rid) of a Garmin
I admit that I had to do a double-take when I reviewed the more than 200 new highs earlier this week and saw Garmin (NASDAQ:GRMN) among those names.
As a refresher, Garmin operates in a number of business segments, including automotive and marine-based GPS systems, as well as fitness-based wearables. It's not hard to understand why Garmin shares have found new life recently, with the fitness-based wearables market expected to take off over the next decade. If you needed further proof of this, we saw tech giant Apple just last week unveil a number of upgrades to iOS 8, including a health kit designed to allow users to easily track a number of vital health statistics with one app (as opposed to switching between apps). This is clearly a multi-billion dollar trend, and investors expect that Garmin could reap solid rewards from wearables.
Also adding to the allure of Garmin is the fact that it's approved a dividend that will yield 3.3% assuming no change in the company's share price moving forward. At 3.3% investors are getting almost as good a return as a 30-year U.S. Treasury bond. Plus, short-sellers tend to avoid dividend-paying stocks since they're often a sign of a stable or growing business.
As for me, I continue to believe that what gains Garmin will deliver from its fitness segment will be more than countered by weakness in its automotive and marine segment. The main concern with the bulk of Garmin's product line is that a mobile device (i.e., smartphone or tablet) can do the same job as a Garmin GPS device for free! It's no wonder that Garmin's automotive revenue has been on a monumental slide that likely isn't going to end anytime soon.
Additionally, Garmin isn't the only company that'll be competing in the wearables space, even if its shareholders believe it will be. The aforementioned Apple, along with Nike and a number of other action sports companies, are going to quickly crowd this space given the multi-billion dollar potential behind it.
Finally, looking at the company as a whole -- including its rapid fitness segment growth and its precipitously declining automotive business – Garmin's growth rate remains an anemic 2%-3%, which would work if it were trading at a forward P/E of around 10. But it's not. In my opinion, at a forward P/E of 20 Garmin would have to execute its strategy flawlessly in order to simply maintain its current valuation given the potential for product obsolescence.
Its dividend might appear enticing, but dig a bit under the surface and there's not a lot of substance to Garmin.