We think it's time to book profits on the following five stocks owing to valuation concerns. Each of these names trades at substantial premiums to book values and cash flows, and now maybe the time to exit positions from the long side and lock-in profits.
While it is always heartbreaking to sell a stock before a major run-up, it is better to "sell too soon" than it is to wait until it is too late to catch a decent bid for your portfolio dogs when valuation and growth rates make the name a sell from a fundamental standpoint.
Qlik Technologies Inc. (QLIK): The company is a major player in the technology world, but we think heady web valuations have spilled over to the cloud-computing industry. We would look to sell or possibly short QLIK provided that the overall stock market breaks lower. In the face of a rising stock market, shorting seemingly overvalued stocks can lead to financial misery, so make sure to set tight stop-loss orders.
Even with more losing trades than winning trades, investors who set hard stop-loss orders profit because their winners, although few, make up for many small losing trades. In the end, this type of trading strategy works pretty well on the short side when married with strong technical analysis. While QLIK looks okay from a technical perspective, the fundamentals are questionable when compared to the company's market valuation which makes this stock a potential short.
Amazon.com, Inc. (AMZN): The world's favorite online retailer is quite expensive on market multiples and fundamentals. We believe that a premium multiple for Amazon is not warranted until the company proves it can translate top-line growth into bottom-line profits. Furthermore, we think the states have the right to tax AMZN's revenues and that eventually the loophole for this company will close, which could be a win for the mom-and-pop shopkeepers down the street. A trailing PE of 130 is too high a valuation to put on most businesses and especially for a mature company like Amazon.
LinkedIn (LNKD): Investors have sent shares of LinkedIn higher in recent months as the stock has rallied some 50% from last year's lows in the $60s. We think the stock is overvalued, but warn traders not to short the stock directly due to the high cost of borrowing shares and the low float nature of the stock. Instead, we recommend a bear call spread strategy, which can earn money even if LNKD rises slightly over the next few months.
Traders could buy the June $120 calls and sell April $90 or $100 call options. In using this strategy, even when you get it wrong in the short run, you have time decay working on your side, plus you have a hard stop-loss order which should help even the most overworked hedger sleep well at night. At 800x earnings, LNKD's valuation looks more than a little stretched to us.
iShares Russell 2000 Index ETF (IWM): We have been vocal bears on the Russell for a couple of years now, because we felt the index was in a bubble back in 2007 and is again in bubble territory in 2012. While we wouldn't short it outright here, we think a similar bear call spread strategy makes sense for investors either as a hedge against existing long positions or as a more speculative market direction play.
By purchasing a higher strike call and selling a lower strike call, many of the risks from this type of trade are mitigated and the margin required to make such a trade is considerably lower than the margin required to simply sell naked call options. Besides that, selling naked call options is considered by most brokerage firms to be the riskiest type of trading strategy due to the potential of unlimited losses on a short call position. Risk management, therefore, is the key to any option-selling income strategy.
Sears Holdings Corporation (SHLD): Sears has been on a historic run lately, moving from $40 to $75 at breathtaking speed. We think the best-news case is slowly starting to be priced into the stock and recommend longs take some incremental profit or cut smaller losses in the stock because of the stellar run in shares.
SHLD is now trading at a substantial premium to tangible book value, and even though the name is highly shorted, the stock could retrace some of its gains based on simple mean reversion/supply and demand issues. Even if Sears has substantial off-balance-sheet real estate value, we think taking some profits off the table makes sense after the one month 100% run-up, given the shares are trading for double tangible book value.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.