You would think that fiscal cliff worries would be putting the kibosh on any new 52-week highs, but that's simply not been the case. 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. Bank of America (NYSE: BAC ) , for instance, has crested the $10 mark for the first time since July 2011 as new foreclosure filings fall and its cost reductions begin to take hold. At just 51% of book value, Bank of America could yet have room to run.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
My predictions are often contrarian, sometimes controversial, and I'll rarely apologize for it. That's why I'm sure to get my fair share of "boo birds" by selecting warehouse retailer Costco (NASDAQ: COST ) to underperform over the near term. Keep in mind this will be a shorter underperform selection than normal, but I have plenty of reasons to be skeptical about its near-term growth prospects.
To begin with, Costco announced last week that it'd be paying a special $3 billion ($7 per share) dividend before we go over the fiscal cliff, to avoid higher dividend taxes. That's fine and all, but Costco just eliminated two-thirds of its outstanding cash with this dividend and gave investors little reason to return to the stock for income purposes with a yield of just 1.1%.
Second, in what world does Costco think it won't deal with the same pricing pressures that have hampered premium grocer Whole Foods Market (NASDAQ: WFM ) ? Consumer spending is still constrained despite rare positive notes from Kroger (NYSE: KR ) , and Superstorm Sandy certainly didn't do anything to help inspire confidence in spending this holiday season.
Based on median growth estimates that range anywhere from 6% to 8%, and valued at 21 times forward earnings, investors are paying a pretty rich PEG ratio of 3 for Costco. I agree that it holds a pricing advantage over its peers due to its bulk-buying approach, but its paltry dividend and premium valuation are simply too rich for my blood in the meantime.
Toro, Toro, ole!
Even though lawnmower and snowthrower manufacturer Toro (NYSE: TTC ) took quite a hit yesterday on news of a decline in fourth-quarter earnings, I feel that a further dip may be merited.
For the fourth quarter, Toro reported an 8% decline in sales as its earnings dropped to breakeven from a profit of $0.08 in the year prior. Its gross margin did, however, expand 100 basis points to 33.3% and its EPS has received a nice boost this year thanks to the continued repurchase of outstanding shares. Looking forward, Toro anticipates 4% to 5% revenue growth in 2013 as normalized weather patterns should help snowthrower sales and new home sales should spur lawnmower purchases.
In my eyes, Toro is a company that's valued at 17 times forward earnings that's struggling to grow and relying on share repurchases and cost cuts to drive EPS growth and mask its weakness. Don't get me wrong, I like the Toro name over the long term, but fiscal cliff and spending pressures are going to drag on sales over the near term as consumers holster more of their disposable income. In addition, I find Toro's dividend to be brutally uninspiring at a 1% yield. Instead, I'd suggest switching up Toro for multinational farm machinery equipment company Deere (NYSE: DE ) which offers double the yield at 2.2%, trades at a much lower forward P/E, and is projected by analysts to grow by a similar growth rate to (if not better than) Toro next year.
Valuations in the integrated circuitry sector are depressed almost across the board. Companies that make adapters, switches, and radio frequency products for devices from cellphones and servers to automobiles are seeing earnings dip and international markets become more challenging. Then there's Hittite Microwave (NASDAQ: HITT ) which has pulled a rabbit out of its hat and managed to vault to a new 52-week high despite an already frothy valuation.
Despite being optimistic about communication equipment circuitry suppliers, my liking for Hittite came to a crashing halt after reading its latest earnings report. For the third quarter, which it reported in late October, total sales dragged lower by 1.4% year over year as net income dipped an unbecoming 21%. Were these results out of the ordinary for the sector? Not one bit, especially considering that about half of Hittite's revenue comes from outside the U.S., where negative currency translation figures are creaming corporate bottom lines without prejudice. What doesn't make sense is how Hittite has managed to boost its forward P/E to 26 or its price-to-sales above 7 without any meaningful growth!
On the plus side, I will give Hittite credit for a pristine balance sheet ripe with $12 in cash per share and no debt, but beyond that, I'd need to see U.S. GDP growth of 4%-plus in order to be excited about Hittite at 26 times forward earnings.
This week I decided to take a break from bashing broken business models to look at valuations that had gotten ahead of themselves. These three companies all have viable shots of being winners over the very long term, but over the next few quarters, they look like a fool's bet (note the small "f" there!).
I'm so confident in my three calls that I plan to make a CAPScall of underperform on each one. The question is: Would you do the same?
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