Short sales are bets that particular stocks will fall. They are a risky technique because when you s...
Short sales are bets that particular stocks will fall. They are a risky technique because when you sell stocks short, it is possible to lose more money than your initial investment if the stocks later rise.
In early December, I covered (discontinued) most of the short sales in my portfolios as I expected a rally in December and January. Now we have seen a rally, but I suspect it will peter out very soon. Over the next few weeks I expect to rebuild the 'short side' of portfolios for clients who can stomach the risks.
The nine companies I am going to name in this article are not necessarily stocks I am going to sell short. But, in several cases, I am considering it. In any event, they are stocks I would at least think twice before owning.
These nine stocks emerged from a weekend analysis using Bloomberg stock-screening software. I started with all US stocks that had a market value of $1bn or more and sold for at least three times' book value (corporate net worth per share).
Three financial ratios
That gave me a field of 683 stocks. From those, the computer selected the three most expensive based on price-earnings (P/E) ratios, the three most expensive by price-revenue ratios, and the three with the highest ratios of debt to shareholders' equity. And there were my Nonsensical Nine. Let's look first at those with the highest price-earnings (P/E) ratios. These are popular stocks, and investors expect great things from them. The problem is that great expectations are hard to meet, let alone exceed. And only by exceeding expectations do stocks advance.
The highest P/E, 3,237, belonged to Manugistics Group, a software developer that helps companies run manufacturing processes. The Maryland-based company has earned a penny and a half per share in the past 12 months and sells for $48.56. Its best year was 1998, when it earned 33 cents a share. So it is selling for 143 times' peak earnings and analysts don't expect that peak to be revisited in 2001 or the year after.
Bruker Daltonics, with headquarters in Billerica, Massachusetts, makes mass spectrometry and other analytical equipment used for detecting substances in minute concentrations and for identifying disease-causing organisms. The company has a P/E of 1,050 and a share price of $21. Analysts predict earnings of three cents a share for 2000 and six cents for 2001.
Vitria Technology, of California, makes software for real-time electronic commerce. Its revenue for the past two quarters equates to about $165m a year. The P/E ratio is 703, since the stock is at $7.03, and earnings for the past four quarters were a penny a share.
Next, let's look at the companies with the highest price-sales ratios. At the top of the list is ImClone Systems, a New York-based biotech firm trying to develop, among other things, cancer vaccines. The price-sales ratio (by the Bloomberg database method) is 1,102. The company so far has scant revenue and no earnings, yet is valued at $2.5 billion in the stock market. If ImClone comes up with a cure for cancer, or even for some cancers, $2.5bn may be cheap. Then again, another company could come up with an even better drug.
In second place in the price-sales ratio, at 562, is Titan Pharmaceuticals, which is developing medications for the treatment of cancer, schizophrenia and Parkinson's disease.
Analysts are counting on success for a new schizophrenia drug. They're probably right, but you're paying for it in advance. If they're wrong, you could lose 50% in a day.
Third by price-sales ratio, at 282, is Human Genome Sciences. Based in Maryland, the company carries out advanced research on diseases and medications related to human (and other) genes.
With all due respect to the company's science, its financial results are not awe-inspiring. It has posted losses in 12 of the past 13 quarters.
The company came public in 1993 and its five-year revenue trend is negative. Its debt as of 30 September 2000 was 110% of equity.
Speaking of debt, let's conclude by looking at the three companies with the highest ratios of total debt to stockholders' equity. (I have excluded financial companies, many of which are designed to operate on borrowed funds.)
Solutia had the highest debt-equity ratio, with debt amounting to 56 times' shareholders' equity. Based in St Louis, Solutia makes specialty chemicals, nylon and acrylic fibres.
Solutia was born in debt when it was spun off from Monsanto in 1997. Since then, its debt has crept higher and stockholders' equity has fallen. The company has shown a profit every quarter, but the profit has declined (on a year-over-year basis) in each of the past four quarters.
7-Eleven still buried
7-Eleven, which operates convenience stores, was second with a debt-equity multiple of 25. The Dallas-based company has never fully recovered from disastrous losses in 1990 and 1992. It is 86%-owned by three Japanese companies.
Campbell Soup had the third highest debt ratio of 23 times' equity. I noted Campbell's high debt level in August 2000 and since then the stock has risen 20%, but I believe it is vulnerable. Its earnings are almost unchanged for the past five years and revenue has slightly declined.
In calling these stocks the Nonsensical Nine, I am engaging in a bit of rhetoric. Some of these stocks will doubtless score gains. However, I believe the odds are stacked against them.
When a stock is extremely outside of reasonable valuation measures or burdened by excessive debt, the chances are fairly high that it will trail behind most of the market.
John Dorfman is president of Dorfman Investments in Boston and a columnist for Bloomberg News
Despite improved risk appetite
FOS award limit increase
Relates to 136 million transaction reports
Ceremony will take place 13 November