Better-than-expected earnings reports continue to be the buzz of the market, with more than 800 companies currently sitting within 5% of a new 52-week high. For optimists, these rallies may seem like a dream come true. For skeptics like me, they're opportunities to see whether these companies have actually earned their current valuations.
Keep in mind that some companies do deserve their current valuations. Following a very rare earnings miss last quarter, Apple (NAS: AAPL) blew the doors off even the most optimistic Wall Street estimates and easily leapt to a new all-time high. I highly suggest you check out Fool colleague Evan Niu's synopsis on just how prolific of a quarter this was for Apple.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
Rare drug, even more rarefied territory
Even though every sell recommendation comes down to valuation, rarely do I recommend dumping a stock just because of its valuation. However, that's exactly what I'm going to do in the case of Alexion Pharmaceuticals (NAS: ALXN) .
Alexion's treatments specifically target rare diseases that often have little competition associated with them -- and to be honest it's worked quite well. Alexion is profitable, has no competitors for at least the next three years for its blockbuster blood disorder treatment Soliris, and has ample cash on hand to facilitate the purchase of smaller biotechnology companies focused on rare diseases.
My beef with Alexion is that even if it focuses on growth by acquisition, its growth rate is slowing, yet it's valued at a pricey 45 times forward earnings. By the time Alexion's profit potential catches up with its current market value, competitors will be streaming into the market. At 13 times book value and 19 times price to sales, I'd recommend passing for better pastures in the biotech space.
Don't settle for standing still
A company that doesn't seem to move forward is one you should always be concerned with, because it often lacks the drive to innovate.
VeriSign (NAS: VRSN) , a domain name registrar and infrastructure assurance provider, has been muddling along for the better part of a decade now. Its ability to turn a profit has been erratic at best, and in recent years, its operating income has taken a major hit outside of the one-time gain it received in 2010 from selling its Authentication Services business. Yet VeriSign has simply been content repurchasing shares to drive the perception of EPS growth. Since 2005, its count of shares outstanding has actually dropped from 265 million to 170 million.
While I'm not saying it's a bad idea to repurchase shares, I am saying that with a 12-month trailing P/E ratio that's nearly triple its five-year average and a price-to-cash-flow ratio near a decade high (theoretically, the lower the number, the cheaper the stock), it may want to focus on innovating instead of muddling along. I'd be a seller of the stock here.
Spiking the food
I'm not exactly sure what they're spiking the food with at TheFresh Market (NAS: TFM) , but it must be good because shares are trading near a 52-week high. But here's the real kicker: The company is valued at 75 times trailing-12-month earnings despite the fact that it has followed three straight quarterly beats with an earnings miss in its most recent quarter.
Now compare this company to Whole Foods Market (NAS: WFM) , which is still trading at a premium (40 times trailing-12-month earnings), but pays a dividend while offering a similar growth rate to The Fresh Market. On top of this, Whole Foods hasn't disappointed analysts come earnings time in more than a year. I really don't understand why anyone would opt to own The Fresh Market when you can get the same growth rate plus a dividend from Whole Foods.
This week, I balked at three profitable companies over their valuations. Sometimes switching up for a better value can be the smartest move you can make. I'm so confident in my three calls that I plan to make a CAPScall of underperform on each one. The question now is: Would you do the same?
Share your thoughts in the comments section below and consider adding Alexion Pharmaceuticals, VeriSign, and The Fresh Market to your free and personalized watchlist so you can keep track of the latest news with each company.
At the time thisarticle was published Fool contributor Sean Williams has no material interest in any companies mentioned in this article. A trip to the supermarket for him is considered a success if it lasts less than 10 minutes. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool owns shares of Apple and Whole Foods. Motley Fool newsletter services have recommended buying shares of Apple and The Fresh Market, as well as creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that never needs to be sold short.
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