Sell These Three Stocks Before Everyone Else Does

Includes: AAPL, ISRG, JEC
by: Alan Brochstein, CFA

One of my favorite parts of Investors Business Daily, the best investment newspaper to read for reasons beyond because everyone else reads it, is the occasional feature where they highlight a stock from the past and ask the reader whether it was a buy or a sell. In that spirit, what should an investor have done with this mystery stock in late 2004? (Click all charts to enlarge.)

As you can see in the chart below, which includes the name of the company, it was a sell. I had expected so back then, and here is why. 2004 was a pretty flat year for the market and one in which most companies were showing deceleration in earnings after the explosive growth in 2003. As a consequence, there were several stocks that benefited from “crowding in”, as investors had to own the fewer and fewer names that were showing acceleration. As you can see, this company was enjoying accelerating EPS (note that the slight deceleration at the end wasn’t reported until early the next year). You can also see that the PE was back to the bubble highs and the PEG ratio was an astronomic 2.4X. Of course, starting the first trading session of 2005, the stock got hammered and ended up underperforming the market the next year. Why then, and not a little earlier? Two reasons: Tax consequences and window-dressing by institutional portfolio managers. I used this single example, but there were several names from that year (and every year) that illustrate the point.

So, which stocks are candidates this year for a trade if not an outright sell? I used StockVal and identified many candidates that were extended and expensive, widely owned institutionally and not facing any binary types of events, but I settled on three in particular that I believe could suffer from significant selling out of the gate: Apple (NASDAQ:AAPL), Intuitive Surgical (NASDAQ:ISRG) and Jacobs Engineering (NYSE:JEC). I am not suggesting that these are long-term sells, but they could in fact be.

AAPL is the most expensive of the 27 S&P 500 stocks with a market cap in excess of $100 billion. In fact, AAPL and GOOG are the only mega-caps with a PE in excess of 21. Note that the stock has been soft in each of the past two years. I am inclined to think that this may be more than just a short-term sell, but calling a top on this one has been quite challenging. Steve Jobs escaped pancreatic cancer and the options back-dating scandal, so maybe he can avoid the rapidly deteriorating consumer spending environment. I see support at 155.

I am so reluctant to mention ISRG, as it is truly a great company. As I have learned, though, never fall in love with a stock. While ISRG is a monopoly of sorts, there are no assurances that they will keep blowing away estimates. A hiccup here on machine placements, which are still about ½ of sales, would be devastating. Will it happen? No clue, but it sure could (it has before). Hospitals aren’t the best capitalized entities out there and they could sure pause. It would most likely be a buying opportunity. Even if not, though, the fear of such an event could surely knock 10-20% off the stock between now and when they report Q4. I see support at 265.

Of the three, this is the one I know the least. I do know that it and its peers are riding tremendous global expansion themes. Margins are expected to expand to an all-time high of 4%. Any sort of concerns about a slowdown in China or India could be a catalyst (if one is necessary). Over the past 20 years, the PE has been between 10 and 33, with a median of 17. I see support at 81.

Disclosure: No position in any of these stocks