Stocks currently on high valuations will dive dramatically as recession kicks in
Three signs that the US is in a recession are: President George W Bush is so concerned about the economy he says the social security surplus isn't untouchable; hundreds of thousands of people have been laid off; and some economists are even starting to say so.
Putting together the anecdotal evidence, the chance we are now in a recession is about 70%, I'd say. If that's the case, a lot of companies may report disappointing earnings for the next several quarters.
Some of these stocks are vulnerable, selling at a high multiple of earnings and book value (corporate net worth). Highly valued stocks tumble more than others when disappointment hits.
As of 28 August, 1,153 US stocks had a market value of more than $1bn and about 13% had a price of more than 40 times the past 12 months' earnings.
In some cases, the recent earnings are depressed and a recovery is expected. But most sell for more than 35 times estimated earnings for the current fiscal year and go on the warning list. I eliminated any stock that sells for less than 4.5 times book value, leaving 66 companies on the high-priced list. Here are five I am particularly worried about.
Genzyme, based in Cambridge, Massachusetts, is a rarity, a biotechnology company that makes money. It turned a profit for the past four years and is expected to earn $1.19 a share this year, up from $1.13 in 2000.
Its five-year earnings growth rate, though, is 14.5%, only one percentage point better than average. If analysts are right, the growth rate this year will be less than 6%, yet investors are paying 52 times the past four quarters' earnings for Genzyme and 47 times estimated 2001 earnings. I think it's too much.
King Pharmaceuticals is a stock I have sold short in a few client accounts. The Bristol, Tennessee, company makes brand-name prescription drugs and does contract manufacturing for drug and biotechnology companies.
At $45.30, King stock sells for 77 times the past four quarters' earnings and 45 times estimated 2001 earnings. That's a high multiple even if analysts are right in saying King will show earnings growth of 22% a year in the next five years.
The analysts may be too optimistic. Now that King has annual sales of close to $800m a year, it will be harder to sustain rapid growth. King showed year-over-year quarterly earnings declines in four consecutive quarters from the second quarter of 2000 through the first quarter of 2001.
Krispy Kreme, out of Winston-Salem, North Carolina, makes delicious donuts but the stock is too fat, in my opinion. At $29.62 a share, it sells for 86 times the past four quarters' earnings, ten times book value and 4.7 times revenue. That's a heck of a lot to pay for a doughnut shop chain, however good the doughnuts.
Protein Design, with headquarters in Fremont, California, makes monoclonal antibodies for the prevention and treatment of a variety of diseases. A specialty is adapting mouse antibodies for use in human drugs.
One of its most promising drugs is Nuvion, which has shown positive results in helping combat graft versus host disease in people who have received bone marrow transplants.
My hat is off to Protein Design for its innovative and useful work. But it stays on where the stock is concerned. At $60.18, the shares are selling for 752 times the past four quarters' earnings, 1,620 times this year's estimated earnings and 64 times revenue. I don't believe any stock is worth that much.
Finally, I'd warn you off Xilinx Inc. This San JosÃ©, California, company makes advanced integrated circuits, software design tools and other computer products. It is the largest maker of programmable semiconductors.
The first question a potential investor in Xilinx must ask is how long the slump in the computer industry will last. I would guess a recovery will begin in 2002.
Analysts expect Xilinx to post earnings of about 22 cents a share for the fiscal year that ends in March 2002, down from $1.08 in fiscal year 2001. If that happens, fiscal 2002 will be the company's worst year since 1995.
The stock has already reflected this dark prospect by declining from a peak near $95 in July 2000 to the current price of $37.58. However, at 43 times earnings and 8 times revenue, I believe Xilinx is still vulnerable to further jolts.
Could I be wrong about any of these stocks? Sure. But if they, as a group, rise in the coming 12 months, I promise to publicly humiliate myself in a follow-up column.
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