Buying These Stocks Is Fighting Absurd Odds
Posted: February 21, 2017
Some things shouldn’t be done. Like wearing white socks with a dark suit. Telling someone what’s wrong with their fiancée. Or buying stocks at 100 times revenue.
People keep doing it, of course. These are hope stocks. But the chance of investors’ hopes being fulfilled is remote.
The average stock these days sells for 2.1 times the company’s revenue per share. Historically, an average ratio is about 1.4. Companies whose stocks sell for 100 times revenue or more are usually biotech companies seeking a cure for cancer or another major disease.
I’ve written 12 columns over the years, warning people away from such stocks. On average, the 12-month return for the stocks I wrote about has been negative 31.7%.
By comparison, the average return for the Standard & Poor’s 500 Index has been positive 8.6%.
Nine of my 12 warning lists have shown a loss, and 10 have under-performed the Standard & Poor’s 500 index (as they should).
Bear in mind that my column recommendations are theoretical and don’t reflect actual trades, trading costs or taxes. Their results shouldn’t be confused with the performance of portfolios I manage for clients. And past performance doesn’t predict future results.
Last Year
Last year was one of the two years when my warning list perversely did better than the S&P 500. I made negative comments about three stocks, and two of them did under-perform the index. But Acadia Pharmaceutical Inc. (ACAD) rose 110%.
Acadia had a drug, Nuplazid, approved for the treatment of psychosis associated with Parkinson’s disease. In addition, the stock benefitted from takeover speculation, with rumors pointing to several possible suitors.
New Warnings
Of the 61 stocks on which I have given “100 times revenue” warnings over the years, 45 have declined over the next 12 months. Sixteen have advanced, and only eight have beaten the S&P 500.
The chances for a big loss are substantial. Twenty-nine stocks on my warning lists, or more than 47%, have been cut in half or worse.
With those dire cautions, let’s take a look at three stocks that currently are selling for 100 times earnings or more. I would keep them at arm’s length – or farther away.
Tesaro
Tesaro Inc., based in Waltham, Massachusetts, is a biotechnology concentrating on cancer therapy. It has few drugs in Phase 1 and Phase 2 trials. In the past year, it has gained its first revenue, about $40 million. The company’s market value is $9.8 billion.
The stock fetches 240 times revenue, 19 times book value (corporate net worth per share) and an infinite multiple of earnings. If you want to be whimsical, you can say it sells for 26 times losses.
Holding the stock up are hopes for Nirapabib, and takeover speculation. Nirapabib is a PARP inhibitor; it blocks certain enzymes, potentially helping to treat ovarian cancer and breast cancer. Pfizer (PFE), Astro Zeneca (AZN)and other drug companies are also working on PARP inhibitors.
Liberty Broadband
Liberty Broadband Corp. (LBRDK) is a holding company whose biggest asset is a 9.5% ownership stake in Charter Communications Inc. (CHTR), a major cable television carrier. Liberty Broadband sells for 202 times revenue, but that is partly a statistical fluke.
Due to accounting conventions, Charter’s revenue doesn’t count for Liberty. If it did, Liberty Broadband’s valuation would look much more reasonable. But I would still be uneasy. The cable industry is heavily competitive, and is vulnerable to new competition from wireless technologies.
Charter Communications stock sells for more than 63 times analysts’ estimates of 2017 earnings, and about 43 times analysts’ best guess for 2018. Those are high ratios, and remember that estimates more than a year in advance are tantamount to guesses. Count me out.
Acadia
Finally, I bring back Acadia Pharmaceuticals, for an unprecedented third visit to this warning list. It lost almost half its value the first year, and more than doubled the second year.
I bring Acadia back, not to demonstrate my mule-like persistence, but because its valuations are still in the stratosphere. Investors are imputing a market value of $4.76 billion to Acadia, which had revenue last year of about $5 million.
That works out to a price/revenue ratio of 883, eight times the level I consider absurd.
The big payoff for Acadia will come if Nuplazid is approved to treat schizophrenia or psychosis associated with Alzheimer’s disease. It would then be a stunningly successful company. But I still think the stock is overpriced.
Disclosure: I have no positions (long or short) in any of the stocks mentioned in today’s column, for myself or for clients.