With all of the headwinds swirling around stocks today, many investors are seeking the safety of cash. It’s a wise move, but not for the reasons you may think.
Cash is not just “safe,” but it is also firepower for the next major upward move in the stock market. Right now, the market is tumbling, but it’s crucial for you to be in a position to jump into the market when a bottom has come in. You’ll know it’s there when the market is no longer plunging (or occasionally surging) and instead is trading in a tighter range.
Among your portfolio’s best performers.
It may seem counterintuitive to part with your most impressive stock picks right now, but you need to know two things.
First, they may eventually succumb to the current weak stock market, and their likely higher-than-normal price-to-earnings (P/E) ratios means they could fall by a hefty amount.
Second, the losers in your portfolio are just as often a victim of poor market sentiment, and can often be oversold in these times of distress.
With that in mind, I’ve compiled a list of 2012′s top-performing stocks in the S&P 500 and S&P 400 (which is comprised of mid-cap stocks). Every one is up at least 25% since the year began, and all sport a forward multiple that is at least 50% higher than the market average (based on both 2012 and 2013 earnings forecasts).
I got a chance to dig into this group, and have drawn a clear conclusion. These stocks have mostly moved up for justifiable reasons and don’t necessarily make good short candidates. But in many instances, it’s simply hard to see any further upside from here. So converting them into cash right now makes ample sense — especially if you think the market may slip further from here.
Take AOL (NYSE: AOL) as an example. The company caught the market off-guard in mid-April by announcing the sale of roughly 800 patents (and the licensing of 300 more) to Microsoft (Nasdaq: MSFT) for roughly $1.06 billion.
Shares instantly shot up, but now that this one-time event has passed, investors should realize this is a company still struggling for relevance.
First-quarter sales and operating profits were roughly 5% below year-ago levels. And though management has done a nice job of stemming even deeper erosion, it’s hard to see how AOL will again be a growing company.
Monster Beverage (Nasdaq: MNST) is another stock that may have already locked in much of its gains. The maker of energy drinks has been a very solid growth story, and has an impressive stock chart to show for it.
Yet the company’s current growth spurt may be a bit deceiving. Sales grew between 10% and 15% in 2008, 2009 and 2010, before shooting up 31% to $1.7 billion in 2011. Sales are on track to rise another 25% this year, surpassing the $2 billion mark. But it’s unclear if sales can keep rising at a fast pace. Analysts currently expect sales growth to slow to around 15% in 2013 and 2014. But one never knows if a market is partially saturated or fully saturated until the moment that growth cools.
Meanwhile, it’s hard to find a beverage stock that trades for nearly 30 times next year’s profit forecasts — and for good reason. The broader beverage category grows very slowly, and the energy drink segment will eventually feel that pull as well.
Part of the reason this stock is so richly-valued is that rumors have swirled that Coca-Cola (NYSE: KO) or others might want to buy the company. I discount those rumors, but if I’m wrong, then this would be a bad stock to short. Yet it surely looks like a good candidate for profit-taking, as expectations of a further expansion in the forward multiple seem hard to digest.
Lastly, investors have done very well by investing in Cerner (Nasdaq: CERN), but caution is warranted here as well. Cerner’s management is outstanding, capitalizing on the many advantages offered up by the transition toward digital medical records. But a pair of companies in this segment — Allscripts (Nasdaq: MDRX) and Merge Healthcare (Nasdaq: MRGE) — have stumbled badly recently due to poor execution, but also partially due to a market slowdown in the face of the Supreme Court’s review of health care reform. This isn’t to suggest that Cerner is primed to deliver a bad quarter, but the forward multiple looks pretty rich for a company in an industry showing signs of some growing pains. It would be nuts to short a great company like Cerner, but perhaps equally unwise to expect further major upside if you own it.
Risks to Consider: Shorts are actively targeting some of these stocks, and if the market moves back up, then these stocks could get squeezed higher, which is another reason it’s unwise to short them.
Action to Take –> In a rising market, it’s often wise to “let your winners ride.” But in a much tougher market, winning stocks can quickly become vulnerable stocks. You may be able to re-purchase these stocks at lower prices if the market’s downward pull finally affects them. But for now, the wisest option may be to sell the stocks on this list.
– David Sterman
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