With the stock market swinging triple digits from one day to the
next, it's become apparent to me that recent gains are being slowly
harvested. Rather than undergoing an outright selloff, investors
are broadening their list of targets to book gains and raise cash.
Some stocks have been immune to this process, but their too-rich
valuations may soon make them the target for profit-taking or
perhaps even short-selling.
It's easy to find these short-selling candidates. They're the ones
with high price-to-earnings (
) ratios and tepid
growth rates. In effect, they're "high
" stocks (P/E divided by the earnings growth rate). For example, a
stock trading for 20 times next year's earnings and is expected to
boost earnings by 10% would have a PEG ratio of 2. That's quite
high. (Using this measure, stocks with a PEG ratio below 1 are
usually the most appealing.)
With this in mind, I screened high PEG stocks in the S&P 500.
Here's what I've found...
Forest Labs (NYSE:
Although not always associated with the "Big Pharma" plays like
, Forest Labs
one thing in common with them: an imminent loss of a key drug that
will wreck the company's bottom-line, since its sales make up for
almost half of the company's total revenue. Lexapro, a popular
anti-depressant, will lose patent protection on March 14, 2012. In
fiscal 2011, Forest Labs reported about $1 billion in net profits,
or $3.59 a share. However, as a result of Lexapro's patent
expiration, analysts expect per-share profits to fall more than 50%
from a projected $3.70 in fiscal 2012 to $1.20 in fiscal 2013. To
make up for this big hole, the company is scrambling to prep other
drugs for approval by the Food and Drug Administration.
Replacing one large drug with a series of smaller unproven drugs is
a risky game. There's no assurance each of the smaller drugs will
get approval, and there's no assurance doctors will actively
prescribe the new drugs. Because of this scenario, analysts at
Needham are taking a cautious stance. They expect Forest's sales to
peak at $4.3 billion in the current
that ends next March (thanks to Lexapro). In addition, despite
expectations of relative success for a range of newly-approved
drugs, they still see sales dropping to $3.3 billion by 2016.
Shares may look reasonably priced on a trailing earnings basis, but
they look quite expensive in the context of future profits. The
stock trades for more 30 times projected 2013 profits and more than
40 times Needham's projected 2016 profits if you look further out.
If Forest executes perfectly on plan, then shares will likely be
fully-valued. But if the company's drug development efforts prove
challenging, then shares may eventually fall by half.
Intuitive Surgical (Nasdaq ISRG)
Back on Nov. 9, 2010, I suggested that you could
your bets by investing in
while shorting shares of industry leader
Intuitive Surgical (Nasdaq:
Since then, shares of NuVasive are up 32%, while shares of
Intuitive is up 27%. This paired trade would have only made a
. But for patient investors, the pullback for Intuitive I have been
anticipating may still arrive.
Intuitive Surgical pioneered the market for robotic surgery in the
late 1990s and went on to post stunning growth in the following
decade. Sales have risen at least 27% since 2002 (with the
exception of 20% growth in 2009). But thanks to rising competition
from NuVasive and others, a tougher health care reimbursement
environment and the effects of the "laws of bigness" (sales could
hit $2 billion by next year), it's getting harder to move the
needle at a fast clip.
This is not to say Intuitive Surgical is headed for a trouble, but
its best days of explosive growth have passed. Sales are likely to
grow 18% this year, 16% in 2012 and perhaps less than 15% in 2013,
according to analysts' preliminary forecasts.
Merrill Lynch launched coverage of Intuitive in May 2011 with
favorable impressions, but noted concerns that shares carry a very
high valuation relative to earnings and growth. In coming up with
their "neutral" rating, analysts noted the stock would likely be a
better bet at a lower valuation.
Analysts at Goldman Sachs, on the other hand, go a step further,
slapping a "sell" tag on the stock with a $270 price target. They
note Intuitive is becoming more dependent on repeat systems sales
and are concerned that most major hospital accounts have already
been penetrated. The key question on growth is whether the company
can open up a major new procedure category. Since they are a bit
dubious of that happening, analysts continue to see the risk/reward
as "skewed to the downside."
Action to Take -->
In a market that may keep retrenching in coming quarters, these
high-multiple stocks are especially vulnerable and could fall
further father than most. If you own any of the stocks in the table
above, this may be the right time for profit-taking. They may also
prove to be a good short-selling opportunity.
-- David Sterman
P.S. -- I don't know if you're aware of this or not, but a
20-year energy agreement between the United States and Russia is
about to expire. The problem is, this deal supplies 10% of
America's electricity. When the Russians refuse to renew the
agreement, the U.S. will face an entirely new kind of energy
crisis. This disruption could send a handful of energy stocks
through the roof. Keep reading…
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.