Several important data points were released in the past week. The stocks started the week with a mixed investor sentiment. While Dow Jones started in the red territory, Nasdaq composite and S&P 500 was up by a inch on Monday. French and Greek elections were the primary concerns of global markets. As I expected, Socialist Candidate, Francois Hollande, was the winner of the French election. However, the rise of ultra left and right wings in the aftermath of Greek elections was not much welcome. The following day, stocks were down by substantial margins. The complexity of the new Greek parliament caused a negative investor sentiment -- particularly among the European stocks. FTSE 100 closed the day with an average loss of 1.78%. Stocks kept sliding down on Wednesday. Even the rise of wholesale inventories did not have much effect to offset negative trend in equity markets. The Euro-Greek concerns dominated the investment atmosphere on Wednesday. Stocks finally inched into the green territory on Thursday. The U.S. government posted its first monthly budget surplus since September 2008. I think that was one of the best news of the last week. The positive employment report on jobless claims also added fuel to the bullish sentiment. However, the gains did not extend to Friday, and markets ended the second week of May with substantial losses. Even the University of Michigan's bullish consumer sentiment indicator could not help to counter the selling pressure. Basic material stocks were the biggest losers, followed by conglomerates, and technology companies. Only utilities and healthcare stocks posted modest gains last week.
Amidst this investing atmosphere, several stocks made it to new highs in the past few weeks. A stock is usually considered overbought when the relative strength index reaches above 70. That does not mean that these stocks are expensive stocks. I would rather consider them momentum stocks, supported by short-term catalysts. Nevertheless, overbought stocks signal a red flag for contrarian investors. Based on the Relative Strength Index [RSI] indicator, I noticed 4 stocks that are in the overbought territory. Let's see, what is driving these stocks, and whether they are still worth to consider after making significant gains recently.
American Capital Agency (AGNC) - Buy
American Capital Agency is one of the most popular dividend stocks in the market. The company operates as a giant investment fund that invests in agency issued mortgage-backed securities. As an agency-only mREIT, its portfolio consists of securities and collateralized mortgage obligations for which both the principal and interest is backed by state agencies. With a debt-to-equity ratio of 8.11, the company has one of the highest leverage ratios among its peers. It is risky, but well rewarding. The stock returned almost 20% since January.
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The company's most recent earnings report came as a big surprise to the markets. Its first quarter net spread income per share was $1.42, which is 26 cents higher than the consensus estimate. That is a positive error margin of 22.4%. AGNC declared $1.25 of dividends per share, which corresponds to an approximate yield of 15.47%. At the current valuation, the stock trades at a slight premium to its book value. However, given the management's past performance, the premium is well justified. Since the last year, the shareholders enjoyed an economic return of almost 38%. Almost half of this economic return came from capital appreciation, whereas the rest is derived from fat dividend checks.
Looking forward, I can see the dividend to move in line with the book value. The leverage is quite high, and that is a substantial risk for the shareholders. But, the net spread of 2.07% offers some safety margin. Let's assume that the spread stays constant. Multiplying this spread with an average leverage of 8 suggests an average return of 16% for the long-term. Rise in leverage is a serious issue, but without pain, you cannot make any gain. Therefore, I rate AGNC as a buy.
Amazon.com (AMZN) - Sell
Amazon could be the short opportunity of this year. The online retail giant is operating on a razor thin profit margin of less than 1%, but it has a market cap of more than $100 billion. The stock has been a long time high-flier, trading near three digit trailing P/E ratios for a while. However, it lost its mojo in the last quarter of 2011. Investors abandoned the Amazon's ship, heading for safety. The stock, which was testing its resistance of $250 in last October, rolled off the cliff, and lost 25% in the last quarter of 2011. Since January, the stock is stabilized and it was trading within $170-$200 range until last week. Recently, the company reported an income of $192 million, which was well above the analyst estimates. Instantly, the stock jumped by almost 16%, and is currently trading at $227.68.
Do not get me wrong. I am a big fan of the company, itself. Amazon is a great innovation in the society. Its convenience allowed us to easily make online purchases through the Amazon.com website. It also provided a tax-free economy where thousands of retailers promote and sell their products online. However, as a stock it looks like a very risky bet. Amazon's recent filing with SEC also suggests that the company settled a quarter billion tax bill with the State of Texas by agreeing to collect sales tax as of July 1, and committing to create 2500 jobs over the next 4 years. California legislators are also in a long-term battle with Amazon regarding the online sales taxes. A national online sales tax might crush Amazon's already low profit margin. Sure, Amazon.com is big enough to stay on its own feet. With no debt on the balance sheet, and a current ratio of 1.16, it looks like a safe investment. However, one also needs to consider that the stock is trading at 16 times the book value and 89 times the free cash flow. Those valuations seem too high to me. Therefore, I rate it as a sell.
Verizon (VZ) - Hold
As one of the largest integrated communication providers in the U.S, Verizon operates in both wireless and wire-line segments. The wireless segment provides data and communication services. The wire-line segment offers high-speed internet, broadband networking and several other communication-related services through one of the largest fiber-optic networks in the U.S. As of last quarter, this network covers almost the entire U.S. population.
The stock has performed pretty well in the last 8 months. Since its dip of $32 last August, it returned more than 20%. I am big fan of dividend stocks, and Verizon offers a nifty yield of 4.86%. While the payout ratio based on earnings is pretty high, the payout ratio based on free-cash flow is less than 50%. Therefore, dividends have plenty of room for growth. Currently, it pays a quarterly dividend of 50 cents per share.
Big telecom companies such as AT&T (T) and Verizon have very stable business models, where revenues and cash flows are quite easy to estimate. Therefore, they can be perfect substitutes for government bonds. Verizon was able to boost its dividends by more than 30% in the last 5 years. While, the current valuation seems to be on the pricey side of the market, I think Verizon is a good hold for the long-term shareholders.
Next Era Energy (NEE) - Dividend Pick For the Next 5 Years
Established in 1984, the Juno Beach, Florida-headquartered Next Era is one of the largest electricity providers in the U.S. The company serves approximately 8.9 million residents in Florida alone. Last year, around these times, it grabbed my attention, as it was too cheap to ignore. I listed it as a dividend pick for the next 5 years. Since then, the stock returned about 16%. Not bad for a utility company.
This year, Next Era returned 8% so far. Given the company's past record, I think it will return about another 8% in the remaining part of the year. Analysts are not that much bullish on the company. They have a very conservative growth estimate of 5.7% which is lower than the past 5 year growth of 7.3%. Next Era has been a slow, but steady upside mover. In the last 10 years, Next Era was able to increase its earnings by 120%, whereas dividends more than tripled in the same period. Currently, it offers a quarterly dividend of 60 cents per share, which is 5 cents higher than the quarterly dividends from the last year. The RSI index suggests NEE as an overbought stock, but I think, it is still cheap. Therefore, I keep my rating on the stock, and suggest it as a dividend pick for the next 5 years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.