Does your portfolio hold a ticking time bomb?

With earnings season underway, investors are being reminded that nosebleed valuations can lead to serious losses.

By StreetAuthority Jul 11, 2013 9:44AM

Arrow Down (© Kyu Oh/Photodisc/Getty Images)By David Sterman


As earnings season gets underway, investors have been delivered a huge jolt in one of their favorite stocks. It shouldn't be a huge surprise, considering this stock was one of the most expensive stocks in the S&P 500 ($INX). But it's a wake-up call for any other pricey stocks. If you own one of them, be sure you are not getting in front of a train wreck.

The stock in question, Intuitive Surgical (ISRG), traded at around $580 in February. Thanks to a stunning one-day plunge, shares are suddenly flirting with the $400 mark. Tepid quarterly sales get the blame, though the size of this stock's drop is surely due to the stock's valuation.


Back in February, when this stock was making fresh highs, it was valued at more than 30 times projected 2013 profits. Considering that profits were on course to grow around 15% (from 2013 to 2014), that was an unconscionably high earnings multiple.
 
After conceding that second-quarter sales would likely trail estimates by $50 million, analysts have been busy ratcheting down future growth assumptions. A major concern: Sales grew 23.5% in the first quarter (on a year-over-year basis) but just 7% in the second quarter.

The ever-tougher spending environment in health care is a key factor (and something you should consider if you own other companies that make medical devices), and even after the huge plunge, investors need to tread lightly with this falling star.

Beyond the quarterly shortfall, analysts at JMP Securities noted that "the reasons cited (conservatism on the part of insurers/physicians and a tougher capital sales market) introduce longer term, more unpredictable concerns." That's not a healthy backdrop for any stock with a high price-to-earnings (P/E) ratio.
A compounded problem
As the ISRG situation reveals, high P/E stocks are vulnerable on two fronts.

If earnings estimates are lowered, then the ideal P/E for those lowered profits should also be lower. For example, a company that is boosting profits at a 30% pace and trades at 30 times its $3 a share earnings forecast would be worth $90. But if analysts lower their profit growth rate assumptions (and hence target earnings multiple) to 25 after a company lowers its earnings per share (EPS) guidance to $2.50, then shares would fall from $90 to $62.50 (2.50 x 25).

Across the S&P 400 and S&P 500, there are 93 companies that trade for more than 30 times projected 2013 profits. As we head into earnings season, these are precisely the companies that will be under the gun to deliver robust results and forward outlooks.

Here's a quick view of 15 pricey stocks.

Risks to consider: As an upside risk, pricey stocks are often heavily shorted, and further advances in this bull market could lead to short covering, which could push these stocks even higher.

Action to take:
These companies are not only subject to so-called execution risk (that is, they must deliver on the high expectations in place for them), but they are also subject to market risk. If the market starts to head south, then these are precisely the kinds of stocks for which investors will "shoot first and ask questions later." That's why it pays to stick with stocks that represent solid values or dividend yields. They are far more likely to hold their own if the market weakens.


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.
 
93Comments
Jul 11, 2013 11:15AM
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Like I always say, stock wealth is neve realized until you sell and the cash is in the bank.  until then all you have are monthly statements with numbers on them.
Jul 11, 2013 11:43AM
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Typical. These so-called journalists write a whole article without mentioning the underlying reason for the Intuitive Surgical crash. News media started calling it "robotic surgery" (because that sells papers), when it's less "robotic" than a kid's radio-controlled car. That opened the way for the ambulance-chasing lawyers to start adding them to their lawsuit lists, for ANY complication after surgery regardless of how tenuous the connection. You knew they were in for trouble when the real slime--the lawyers advertising on TV--started running ads to rake in anyone who'd had surgery using the equipment. This led to hospitals backing off on purchases, at least until the smoke cleared. This is how the lawyers are ruining America and the world, when advances are stifled that mean you only need a couple of days to recover vs. a couple of weeks.
Jul 11, 2013 11:15AM
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Well, my newly acquired income funds took a hit, but that only means I have to "go long".....
As opposed to Alias Barely Slowtero, who will always be 'short',  at least according to
his little friend.

The central difficulty is in adopting too brief a view when it comes to the DOW.  Over the long
haul, many have done very well, even without relatives on Wall Street, feeding them
the numbers.  Patience and perseverance, my fellow Blogmericans, can outweigh
a few lucky rolls of the dice.

Thank you and good hunting.

Jul 11, 2013 1:06PM
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Why anyone would pay P/E multiples of 20+ times projected future earnings is beyond me...
Jul 11, 2013 12:44PM
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I wonder who was the richest of the invented personas ?
Nevada Luke ?
Limo Pat ?
Jeep 1865 ?
Foxy Blonde ?
Sargent Frank?
"Regal" Man ?

Jul 11, 2013 12:03PM
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"Regal" Man- I thought I heard someone say your wives name is Bambi ?
She's from NY ?
Confirm that


Jul 11, 2013 12:31PM
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My mistake.
Fat CAT vely vely bad man !
He no likey his tiny BMW caw made for young giwl ?
he no pwoud no mowe !
vely , vely bad man


Jul 11, 2013 12:58PM
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Yes, because Las Vegas is where all the FAT CATS live !
Lounging around the pool in the lovely 130 degree temperatures.
Eating the finest cuisine, pastries, lovely views of sand.
The downtown area ghetto is just a thing of beauty.


Jul 11, 2013 10:58AM
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I'm rich again.  Thank you.  Glad I kept adding to my portfolio all summer.
Jul 11, 2013 1:10PM
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Will you be wearing the normal waiters attire or are you still a busboy ?
Jul 11, 2013 11:42AM
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A synopsis of this author's statement:

Always have a bunch of Blue Chips in the mix.
Good dividends are the best support for those equities.
Stay diversified...

Like old people, old sayings are still relevant, once
one removes the whiff of mold from them. 

Jul 11, 2013 12:50PM
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Hey Little Beaver....... you must spend a lot of time at Denny's to know the nick name of their food.... LMFAO @ You
Jul 11, 2013 12:47PM
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" you can have the BIg Bird at Denny's"

 

What the he11 is that?

Jul 11, 2013 12:52PM
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He works the AM shift at Denny's then moves on to Mortons for the dinner trade.



Jul 11, 2013 12:49PM
Jul 11, 2013 1:19PM
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I think I will have a lunch earlier than usual. All this chatter of Steak.


Jul 11, 2013 12:41PM
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Barry, It`s supposed to get to 95 today.Thank God for air conditioning.I`ll be hitting the

pool early.Are you coming to Morton`s next Wednesday?A Bud only costs $9.Just get

a cab from one of those friendly cabbies on Turd street and go to JFK and I`ll see you

in LV.I`llbuy you a drink and if you`re not too awful you can have the BIg Bird at

Denny`s.

Jul 11, 2013 9:58AM
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Love and hype create valuation bubbles?
Jul 11, 2013 11:39AM
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My clients portfolio's are doing just fine. To get you through the summer and actually GROW  your portfolio; look into utilities( best growth recently), pharmaceuticals, entertainment -theme parks. The 'cash cow' dividend stocks are great for your cash flow but you also need to spur some growth- can't be shorting all the time since this lowers the overall vaule of your holdings.

Jul 11, 2013 11:04AM
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I've spent the past few years rolling my investments into the dildo and porn business.  So, needless to say it's been thriving and steadily moving upward.  Sex is big money in any economy.  The Great Depression saw some of the highest dildo sales in recent history.
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