Don't look now, but at the same time new money has been flowing into the stock market and pushing it to a five-year high, insiders are selling...
According to Vickers Weekly Insider Report, the ratio of insider selling to buying by officers and directors stood at better than 9 to 1.
When you have dumb money buying and smart money selling, it's time to take a look at some possible shorts, or at least take a look at some names that you might want to cut from your portfolio.
There are three basic things you want to look at in terms of finding companies to ditch:
- Insider Selling; and
- Sustainable Business Model
The simplest value of a company can be determined with a price-to-earnings ratio.
If you are going to buy a mom and pop store like a restaurant or a paint company, the rule of thumb for a private investor is to pay about five times the annual income of the enterprise you are buying. That would equal a P/E of 5. This means you get your money back and start earning a return after five years.
When you are talking about stocks, investors are willing to pay a lot more for a number of reasons — not the least of which is liquidity. You aren't married to stocks, as you are to a store or a restaurant; they are easy to sell if things go south.
Another factor to look for is growth. If a company is growing faster than its PE, it makes sense to buy it. Peter Lynch had a rule that you should buy a company with a price-to-earnings growth (PEG) below one.
Don't get me wrong; PEs do matter. There has never been a company with a PE over 100 that didn't crash at some point. (The dot-com bust littered the field with former high-flying, triple-digit PE companies: Yahoo!, AOL, Cisco, Pets.com, etc.)
River of No Returns
Today Amazon.com (NASDAQ: AMZN) leads the market as the most expensive company. Until the most recent quarter, when Amazon lost money, the company had a P/E over 300. In the most recent quarter, AMZN went under water on falling margins.
You would think that would crush the stock price, but you'd be wrong...
Value. Amazon is insanely valued. Since 2009 the share price has gone from $50 to $266. The online retailer now has a market capitalization (shares x share price) of $121 billion and sports a five-year projected PEG of 4.50. (For comparison, another high-flier like Apple (NASDAQ: AAPL) looks like a bargain with a PE of 10 and PEG of 0.53.)
In a word, AMZN is overvalued.
Insider Selling. Over the last six months, insiders have sold 145,305 shares. Jeff Bezos has been dumping roughly $100,000,000 worth of stock a month. This shouldn't give investors confidence. Historically, strong insider selling has pointed to lower share prices within 12 months.
Sustainable Business Model. To top it off, Amazon is fighting massive headwinds. A sluggish global economy coupled with higher federal taxes has put the squeeze on consumers. The high price of gasoline has had a crushing effect on shipping, which means Amazon has to eat the cost on its Prime free shipping model.
And finally, states have enacted sales taxes — which means that in many places, it's just as cheap to go to the local Wal-Mart as it is to wait three days for your widget.
AMZN: Trees Don't Grow to the Sky
If you are long Amazon, sell now.
Netflix (NASDAQ: NFLX)
Netflix, Inc. provides an Internet television network service that enables subscribers to stream TV shows and movies directly on TVs, computers, and mobile devices in the United States and internationally. The company operates in three segments: domestic streaming, international streaming, and domestic DVD.
Value. The company has a market capitalization of $10.30 billion. It has a trailing P/E of 631 and a PEG ratio of 7.62. Profit margins are at 0.48%. The company took off recently due to new deals with content providers such as Disney.
That said, the share price has climbed from $60 in October 2012 to $186 in February 2013.
Insiders. Insiders were net buying at below $75 a share. But more recently, insiders have been dumping after the run-up — including a large 56,436,000 block by Jay Hoag.
Business Model. I like the Netflix model. The company is doing an end-around from your cable company. Many people are switching to streaming videos and shows. But the company faces competition from a host of people including the new Apple TV and our friend Amazon, which streams movies and shows as well.
Bottom line: Netflix is more likely to go back to $75 than it is to go to $350. Netflix is a sell.
Palo Alto Networks (NYSE: PANW)
Palo Alto Networks, Inc. operates a platform that allows enterprises, service providers, and government entities to secure their networks and safely enable various applications running on their networks.
The company's platform comprises Next-Generation Firewall, which delivers natively integrated application, user, and content visibility, as well as control within the firewall through its proprietary hardware and software architecture.
PANW is overvalued at $57 a share.
Value. Again, the company lost money during the last quarter, which means they have a negative PE. The estimated forward PE is 133.47. The five-year projected PEG ratio is 6.85 — well above Peter Lynch's 1.0 rule. Furthermore, consensus estimates for 2013 have fallen over the last quarter and sales are slowing.
Insiders. Insiders have dumped more than $25mm in shares over the past month. The stock is at where it debuted in late July, and there are still plenty of insider shares subject to lockup provisions that will fall off over the next six months.
Business Model. Cyber attacks are in vogue today as Chinese hackers are going after any and everyone. Leslie Stall recently did a segment on 60 Minutes sowing fear and pushing safety.
That said, the stock is priced for these to continue, but it won't last. As we have seen in the past, for every sword there is a shield; for every Trojan horse, a defense.
We've seen this scenario before: Once the attackers show their hand, the solution comes around with the next set of software innovation.
These stocks, like Symantec Corp. (NASDAQ: SYMC), are driven by the news cycle and are extremely volatile. They work well as trading stocks, but poorly as long-term investments.
A hoary old investment genius once told me that stocks go up and stocks go down.
Knowing which is which is the important part.
When you are looking to buy low and sell high, you should look first to value, sustainable business model, and insider selling.
All the best,
Since 1995, Christian DeHaemer has specialized in frontier market opportunities. He has traveled extensively and invested in places as varied as Cuba, Mongolia, and Kenya. Chris believes the best way to make money is to get there first with the most. Christian is the founder of Crisis & Opportunity and Managing Director of Wealth Daily. He is also a contributor for Energy & Capital. For more on Christian, see his editor's page.