As the
market
has crawled ever higher during the past three years, a clear theme
has emerged: When the market slumps, investor pessimism gets
carried to extremes; and when the market posts a strong rally,
things are not as solid as they appear.
Indeed, that's where I think we are right now. The markets are in
the midst of another strong run, though considerable challenges
remain. Sure, we've seen a slew of positive economic reports in
recent days, but the U.S.
economy
is far from healthy. Perhaps of greater concern: companies are
reporting that sales are rising faster than profits, a sure sign
that
profit
margins are slipping back. So if the U.S. grows in the 2-3% range
in 2012, as most economists anticipate, then investors need to
brace for slowing sales and perhaps falling profits in the quarters
ahead.
That's not an argument to dump all of your stocks, but it surely
calls for portfolio pruning. Harvesting winners and raising cash
levels may be the best approach for the current market. Simply put,
any stock that has risen by a considerable amount in recent months
needs to be closely scrutinized to see if it has maxed out and is
primed for a pullback. Some of these fast-rising stocks may be ripe
for short-selling because their valuations now outstrip the reality
on the ground.
The 24 stocks you'll see below have risen at least 30% in the past
13 weeks, and all trade for at least 25 times
forward earnings
estimates.
The list is filled with an unusual group: housing stocks.
KB Home (NYSE:
KBH
)
,
Toll Brothers (NYSE:
TOL
)
and
MDC Holdings (
MDC
)
are all home builders that are being bid up on expectations that
the housing market is about to turn up sharply.
Masco (NYSE:
MAS
)
, which makes a range of building materials, has joined in the
housing rally.
Yet there's a problem that looms. Housing may indeed start to turn
a corner, but any increase in new home construction is likely to be
painfully slow to unfold. The
volume
of unsold existing homes remains at a fairly high level, and that
just counts the houses that are formally for sale. There are a
large number of homeowners that have been loathe to unload their
houses while activity remains slow. But if housing perks up, a lot
of these homeowners may look to list their houses on the market as
well.
Against that backdrop, these new home builders would be foolish to
get ahead of themselves and start building many new homes "on
spec." As Goldman Sachs succinctly noted in a Jan. 12 report
entitled "Housing is healing but not fast enough to ignore
valuations," the firm's analysts noted that "With homebuilding
stocks outperforming the market by 3,500 basis points in the last
three months, we would wait for a pullback or a clearer picture
that housing is healing quicker than it currently is."
Don't gamble on these stocks
In recent months, a number of U.S. states have expressed an
interest in getting into the gaming business. Visions of hundreds
of new casinos dotting the landscape have helped propel
shares
of companies that supply the equipment used in these gaming halls,
such as slot machines, card sorting machines, betting chips and
casino-oriented software. This explains why
Boyd Gaming (NYSE:
BYD
)
,
Scientific Games (Nasdaq:
SGMS
)
and
Multimedia Games (Nasdaq:
MGAM
)
are all up sharply in the past few months.
Take Multimedia Games, a provider of video-gaming equipment, as an
example. At a recent $10, it has soared well past Brean Murray's $7
price target
. That equates to roughly 25 times projected fiscal (September)
2013 profits. The key concern: even with the current stated plans
for new casino openings in many states, this will never be a
high-growth business. Sales peaked at $150 million in fiscal 2005,
and are now stuck in the $125 million to $140 million
range.
Analysts at Sterne Agee say Boyd Gaming is especially ripe for a
pullback. Their $6.70 price target is about 30% below the current
share price, noting that
cash flow
will grow at a slow place this year. For this casino operator, a
move to open more casinos may actually push cash flow lower as many
new casinos chase a fixed amount of customers. You can imagine a
scenario where new and existing casinos grow quiet as consumers
have more of them to from which to choose.
If a number of new casinos get built in coming years across the
United States, then what will itmean for Las Vegas? Presumably,
many gamblers will choose to stay closer to home. Boyd Gaming, with
40% of sales derived in Las Vegas, would have a hard time
maintaining current profit levels, let alone be able to boost
profits.
Risks to Consider:
The rising market lifts all boats, especially high-beta stocks
like these. If the market continues to strengthen, then it may be
premature to sell these fast-gainers.
Action to Take -->
Some of these recent gainers have high short positions, which means
their recent rally may have been fueled by
short covering
. If the shorts found these stocks vulnerable at lower levels and
have been covering positions at higher levels in the face of an
ever-rising market, then these stocks may be suitable to short at
these now-higher levels. Heavily-shorted names from the table above
include:
•
Avid Technology (Nasdaq:
AVID
)
19 days to cover (which is the number of shares held short divided
by average daily trading volume).
•
MarineMax (NYSE:
HZO
)
24 days to cover
• Toll Brothers, which saw short interest rise from 8.8 million
shares at the end of 2011 to 10.6 million shares in the middle of
January
•
HMS Holdings (Nasdaq:
HMSY
)
10 days to cover
• Equinix (Nasdaq:
EQIX
)
, which saw its short position jump 13% in just two weeks to a
recent 4.9 million shares.
Even if you're not looking for
short sale
candidates, many of these stocks look ripe for profit-taking if you
currently own them in long-focused accounts.
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.