Several of the major stock indexes are currently stretched from a valuation perspective and could potentially roll over a bit if Congress and the public decide to rally against higher food and energy price inflation via TBTF (too big to fail) banking and the expansion of the money supply and deficits. While the party rages on in Davos, the public is starting to get angry about paying for this party via higher pump prices. In the Great Depression, the decision to expand the balance sheet of the Fed began with an 89% two year equities rout – today we are sitting near 5 year highs in many widely owned index funds and Americans are beginning to be a bit more skeptical of the Fed’s motives for boosting “asset prices.”
The pressures behind the monster rally are coming directly from QE, which Bernanke now openly takes credit for and once the wind down of stimulus begins to be priced into stocks, many of the overvalued names in this market could finally find some legitimate price discovery. The following 20 stocks are listed due to high valuations, which historically underperform in market corrections. Either that or we print our way to Dow 200,000 and a McDonald's (MCD) cheeseburger runs us $1,000 bucks down the road. I am of the theory that after all else fails, America will do the right thing and reign in the debt eventually and that investors should be a bit more careful right now in US stocks. Peter Schiff said some interesting things about foreign stocks and because I agree with much of his assessment of the dollar I will look to gain overseas exposure here on the long side and stay conservatively net long.
(IWM) – The Russell is trading at 27X earnings and 3.5X book value right now and has nearly reached the highs from 2007 -- $80 being the shoulder of the H&S top formed that year, and serving as major resistance for IWM. The Russell contains many cheap companies to be sure, but the majority of the index is overdone and due for a major fall in my opinion. The Russell was trading for less than $35 just two years ago, and if you ask most small business owners if they are nearly 300% better off than they were in 2009 they will look at you with a glance full of disbelief.
(ITMN) – InterMune Inc. is a biotech play, which normally I stay away from altogether. ITMN, however, lost FDA approval for their lung drug Esbriet last May and the stock fell from $45 to around $10 after the announcement. Now that Europe’s advisory board suggested a trial for Esbriet, the stock has shot back up to $37 per share. I am short the name hoping for a repeat of the crash in May Groundhog Day style. Clearly, the excitement behind the FDA trial was a reason for a run up in the stock, but in Europe only 110,000 people suffer from the rare type of lung disease that Esbriet treats – at a valuation of over $2BN for ITMN, the rosiest scenario seems to be already priced into the stock.
(OPEN) – Opentable is a stock that continues to defy logic, valuation, and gravity. As I am trying to find new shorts, I tried not to repeat the names from my last article on overvalued stocks; however, OPEN is carrying a 140X trailing PE ratio and a 75X forward PE while trades for nearly 20 times sale If the losses in FFIV last week and VMW this evening are any indication of what the market thinks of 100 PE stocks, OPEN holders might want to cancel their reservation for these shares.
(ANF) – Abercrombie has posted some huge numbers this year, but at 43 times trailing earnings a lot of risk to the downside exists if that growth does not continue. The forward PE of 18X is reasonable and ANF is certainly a great company with a popular product, however forward multiples depend on Wall Street analysts and models that don’t always get the whole story correct. I am not advocating a short here due to large operating cash flows, but if it hits a 48-50 trailing PE, I will be back in this one on the short side.
(DDS) – Dillards class B common stock was trading at under $4 a share just two years ago. Today, the stock is trading over $40. While cash flow and book value provide some safety for longs in DDS, the stock is no longer a value play and has the same headwinds and risks that it did in 2008. If the credit cards stop being used to finance things like chrome rims and Blu Ray players, the economy could take a dip and with it consumer spending. Obviously the plan is to give us more dollars with less value through QE but spending patterns may change with the realization of government indebtedness and state solvency issues. At 19X earnings, DDS seems like a bad company with a premium multiple, which is a good recipe for short selling success.
(BXP) – Boston Properties trades for 8X sales and 19.5X EV/EBITDA which makes the shares look overvalued to me. Cash flows from investing activities have sucked up most of BXP’s operating cash flow and the company has had to lever up to pay their dividend. If commercial real estate is the next shoe to drop, BXP will be a decent hedge against your undervalued longs. Be careful, however, as the company has shown in the past that it has significant earning power.
(TYH) – The Direxion Triple Leveraged Russell 1000 technology index is setting up to be a decent short candidate after rallying from $39 in December to over $47 today – this type of action in an already overvalued index suggests that a blow off top may be taking place. TYH is a wide basket of stocks and while some are good values, the majorities of these stocks are overvalued which means that if the market heads lower TYH should be a good hedge for an existing long portfolio.
(IWO) – The Russell 2000 growth index trades at an even higher PE ratio than the
IWM and has broken down much worse than the IWM, which suggests that the higher beta names are leading on the way down as well as the way up. We will keep our eyes on IWO and add to a put spread position if the market starts to sell off here .
(SFSF) – Success factors is a great company in a growing business, but it trades for a 1999 nosebleed valuation of 263X forward earnings. The company has posted many years of historical losses and has yet to turn a meaningful profit. The addition of the Pay Pal guy to the board is certainly a positive development for SFSF, but the stock is priced beyond perfection and any rally should probably be shorted here.
(RVBD) – Riverbed is a small cap cloud play with strong growth and a good market position. The stock, however, could sell off with FFIV, CRM, and VMW which was down 4% today and over 4% after hours. The trend in the cloud stocks is that even when they beat earnings, the stocks drop like a rock.
(VMW) – VM Ware reported earnings above expectations, but guided toward 25% revenue growth in 2011 which is not high enough for Wall Street given that the company has a 100 plus PE ratio. While cheaper than RVBD or CRM, VMW is not for the faint of heart. If I were to try to short this, I would at least sell puts against my short position for some protection.
(NFLX) – Netflix is coming out with earnings tomorrow and the stock has caught a bid recently to $184 or so, which is a 69X earnings multiple. NFLX could either plunge or pop after earnings, but if CSTR is any indication the smart money is probably leaning towards plunge right now. NFLX is a good growth company, but after spiking 300% a 20-30% correction seems about right to me. Some stocks are held up on skyhooks and others are left behind no matter the net asset value or earnings power of the company
(TZOO) – Travelzoo is an old short that I caught in 2007 which reappeared on my overvalued screens when it popped back from $12 to $44 last year. TZOO is “the next Groupon” according to the bulls, but I think it’s probably just the next Taser or TZOO from 2007 all over again. At 50X earnings, TZOO is not exactly a bargain basement Ben Graham stock. The bad news for longs is that it’s only growing revenues at around 13% or so and earnings are flat from three years ago – hardly the type of high profile growth a 50X multiple suggests. While TZOO may be a great company to find deals on, the stock should be looked at like a repeat offender – it’s been pumped and dumped before so make sure you stay on the right side of the tape.
For more ideas for the short book, see my article, “10 Overvalued Stocks Analyzed by Discounted Cash Flows.” I am not recommending investors short these stocks but they may drop from here if persistent/real gaps exist between stock prices and intrinsic values…. happy hunting.