The broad-based S&P 500 may have suffered its biggest one-day slide in more than three months last week, but it takes more than a single slide to make a viable correction, as evidenced by the fact that approximately 46% of all stocks in The Motley Fool CAPS database are at or within 10% of a new 52-week high. For skeptics like me, that's an opportunity to see whether companies have earned their current valuations.
Dollar Tree is one of Realty Income's larger lessees. Source: Random Retail via Flickr.
Keep in mind that some companies deserve their valuations. Take Realty Income (O 0.55%), a real estate investment trust that owns and leases a bevy of commercial properties around the country. While you might be focused on short-term event-drivers such as the polar vortex, which whacked retailers' bottom-lines, Realty Income isn't the slightest bit concerned, as it leases nearly all of its properties to investment-grade retailers under long-term contracts. As of the first quarter, Realty Income's leases averaged 10.8 years in length, while its occupancy rate was a near-perfect 98.3%! Both of these factors lead to steady cash flow and a monthly dividend distribution that currently works out to an annual yield of almost 5%.
Still, other companies might deserve a kick in the pants. Here's a look at three that could be worth selling.
Source: LG via Flickr.
Where's the growth potential?
As I've said dozens of times previously, sometimes you have to remember not to fall in love with companies -- especially when the business dynamics change.
In the mid-to-late 2000s I was fully enamored of AU Optronics (AUO -0.67%), a Taiwanese developer of liquid crystal and flat-panel displays. At that time it was easy to like AU Optronics because flat panel PC monitors, the emergence of smartphones, the introduction of tablets, and the incredible innovation in the television sector made it appear that LCD panels would dominate for years to come. That time, however, has come and gone.
The biggest downside to technology component suppliers like AU Optronics is that as production efficiency for new technologies improves, the cost of the product often decreases as supply and competition rise. This means LCDs are no longer a "wow" factor product but rather a default for tech-hungry global consumers. It also means that a lot of the sectors to which AU Optronics supplies its components have been struggling with weakening margins and inconsistent demand.
Television manufacturers, for example, have seen years of weakening sales as prices continue to creep lower in order to entice consumers to buy. Similarly, PC sales have shrunk demonstrably, giving way to new mobile applications like smartphones and tablets. The end result is that AU Optronics' top line has been stagnant for about seven years, and its gross margin has been in the low single digits or in the red for a bulk of that time.
With revenue growth still expected to be nonexistent through 2015, and the company valued at a whopping 25 times forward earnings, this seems like the perfect opportunity for investors to lock in their gains and look for more attractively valued investments.
Source: Glu Mobile.
I'm rubber, you're Glu
Keeping with our theme of liking a company but greatly disliking its valuation, I give you free-to-play mobile game developer Glu Mobile (GLUU).
On one hand the market for smartphone- and tablet-based gaming apps is growing like wildfire. Although Glu Mobile's games are free to play, Glu is counting on the addiction level of its games to move some consumers to a premium paying level. Also, if it consistently produces popular games then advertisers could take notice, further enhancing its earning potential and diversifying its revenue stream.
In Glu's latest corporate update, just this past week the company noted that its Kim Kardashian: Hollywood game could be its biggest blockbuster of the year, with one analyst proclaiming the game itself has $200 million in annual sales potential (which would more than double Glu's current annual revenue). Glu also notes it simultaneously held the No. 1 and No. 3 spots for most-downloaded free app in the App Store for the iPhone in the latest quarter.
While plenty of things are going right for Glu Mobile, there are a number of concerns I have with the company following a near doubling in its share price since the beginning of June.
First, we have to remember that this is a free-to-play game developer. There are no guarantees that users will step up to the plate and purchase premium services on a quarter-to-quarter basis. Secondly, the game development process can be very hit-or-miss -- just ask Zynga shareholders. Glu Mobile is bound to develop some duds, and investors should prepare for that. Thirdly, the company's best-performing game, Kim Kardashian: Hollywood, is based on a figure who could easily fall into and out of popularity. What this means is it's unlikely it has much long-term staying power, which is going to require continuous investment on Glu's part to keep consumers interested.
But most of all I worry about Glu's slowing long-term growth prospects compared to its profitability. As I just opined, it's pretty logical to expect bad games to weigh on Glu's growth time to time. Based on Wall Street's estimates, Glu's top-line sales are projected to peak in 2016, with full-year EPS dipping to just $0.22 in 2017. I don't know about you, but the prospect of paying 30 times 2017's profit projections for a company that makes free-to-play products in a sector that's notorious for being hit-and-miss doesn't sound appealing. I'd consider using Glu's recent momentum to lock in your gains.
Bidding blind
Lastly, I'm going to suggest investors lock in their recent gains on home-health and hospice care provider Gentiva Health Services (NASDAQ: GTIV) following the company's 100%-plus rally since the beginning of May.
Source: Binomialphoto, Flickr.
The impetus for Gentiva's rocket-ship ascent has been three unsuccessful bids from Kindred Healthcare (KND). Kindred views the ability to geographically expand its home-health business as attractive, and believes adding Gentiva's Medicare/Medicaid-dependent business would be a great fit for its long-term plans. In addition, I suspect the deal would be almost instantly accretive to Kindred. Kindred first offered $14 per share for Gentiva in mid-May, but upped its bid twice since then to $14.50 and now $16.
Gentiva, however, may have other plans. On Friday last week Gentiva announced that another undisclosed party had entered the picture with a $17.25 offer to buy the company. Gentiva has seemingly done everything it can to ensure that it doesn't become a component of Kindred Healthcare, including introducing a poison pill plan to thwart a hostile takeover attempt by Kindred. Gentiva's board announced that it would review this new bid while unanimously rejecting Kindred's $16 offer.
My theory is that regardless of which company proves to be the winner, there's absolutely no value left in Gentiva Health Services at this level.
To begin with, the Centers for Medicare and Medicaid Services -- the body that proposes reimbursement rate increases and decreases -- has made it clear that the passage of the Affordable Care Act will make businesses less reliant on government-sponsored care. Among home-health companies, Gentiva is extremely reliant on the government, which means that, as the CMS suggests, reduced reimbursement rates Gentiva could see minimal -- or even negative -- growth in the coming years.
To add, Gentiva is also working with a monstrous $1.1 billion in net debt. It's not uncommon for home-health providers to carry debt given that acquisitions are the quickest way to grow in the home-health business. This debt leaves Gentiva strongly in the negative when it comes to book value and makes its long-term future a bit dicey if its reimbursement rates are at risk of falling via CMS proposals.
Finally, this decision was made easy with Gentiva trading for more than its latest offer price. Given the above information, a competing superior bid seems unlikely and unwarranted. Investors who were lucky enough to ride this rollercoaster should consider locating the exit sign and heading for the door.
