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Lose 32% of money on popular stocks

| Tuesday, Feb. 18, 2014, 12:01 a.m.

Would you like to lose 32 percent of your money every year?

Then bet on wildly popular stocks — ones that sell for 100 times the company's revenue or more.

I have published nine previous columns on this subject (2000 through 2006, 2012 and 2013). Eight of my nine warning lists have, as I expected, produced returns that lagged behind the Standard & Poor's 500 Index. Seven of the lists have shown absolute declines.

Combining all nine lists, the average decline was 32.65 percent.

Why do people invest in such stocks? They can't resist the gleaming lure of a company with a promising new product — or the hope of one.

Many companies whose stocks sell for 100 times revenue or more are biotech outfits, and a significant number of them are working on cancer drugs.

No one wants a cure for cancer more than I do. My brother and mother both died of it. But stocks should be evaluated mainly on what a company has done, not what it hopes to do.

A mighty thud

My latest list of stocks selling at 100 times revenue or more was published on Feb. 19, 2013. Here are the results:

• Archillion Pharmaceuticals Inc. (ACHN) was down 63.98 percent.

• Ariad Pharmaceuticals Inc. (ARIA) fell 58.85 percent

• Virnetx Holding Corp. (VHC) lost 49.08 percent.

• Lexicon Pharmaceuticals Inc. (LXRX) declined 11.44 percent.

• Ziopharm Oncology (ZIOP) slipped 6.88 percent.

The list as a whole was down 38.05 percent,in a year when stocks were buoyant.

Four of the five stocks highlighted a year ago were biotechs, and three of them were active in research on anti-cancer drugs. Some of them may prove to be good companies. But in my judgment, any stock selling for 100 times revenue has gotten “ahead of itself,” as the market expression goes.

As one example of the kind of thing that can go wrong, consider Ariad Pharmaceuticals. Its flagship drug Iclusig, for treatment of leukemia, was found to increase the risk of blood clots. The drug is still on the market (with increased warnings), but investor enthusiasm has deflated.

This year's candidates

Here are five stocks that sell for more than 100 times earnings. For most investors, this should be considered a list of stocks to avoid. For short sellers, who bet on selected stocks to decline, this might be a candidates list.

Intercept Pharmaceuticals (ICPT): This 12-year old biotech firm based in New York City is developing drugs to combat liver diseases. It has no products on the market yet, but has several products in clinical trials, including one in phase III trials for cirrhosis of the liver.

It also has a drug that shows promise in treating hepatitis that is not caused by alcoholism. Both drugs have large potential markets.

Intercept had revenue of $2.4 million last year, and a market value of $6.7 billion, for a price/revenue ratio of 4,370. That doesn't stop analysts from liking it. All seven analysts who follow the stock rate it a “buy.”

To justify a $6.7 billion market value, you have to assume that the company will achieve about $3 billion in sales reasonably soon.

But these things take time. Microsoft, one of history's most successful companies, reached $3 billion in sales seven years after it introduced its software suite Microsoft Works.

SunGame Corp. (SGMZ): Based in Las Vegas, SunGame describes itself as a “development-stage company engaged in the process of establishing a three-dimensional, virtual world community.” I believe that means that it is developing multi-user online games in 3-D.

With a market value of $5.69 billion and sales last year of $23,000, SunGame has the highest price/sales ratio that I ever recall seeing, more than 100,000.

In my opinion, the company's press releases have a boastful tone, which I view as a bad sign. The stock is listed on the OTC Bulletin Board and is thinly traded. It may be hard to sell if you need to.

Gawk Inc. (GAWK): Gawk of New Orleans is developing a website that will show proprietary full-length films and TV series. If there was ever an area with heavy competition, this is it. Yet this fledgling outfit, with revenue of $23,000 last year, has a market value of $2.4 billion.

Lexicon Pharmaceuticals: This biotech company based in The Woodlands, Texas, still sells for 942 times revenue after its moderate decline last year.

Finally, Ubiquity Broadcasting Corp. (UBIQ) of Irvine, Calif., fetches about 10,000 times revenue.

One of its projects is a feature film set aboard the Queen Mary. Filming is to begin this spring.

I wish these companies success. If they get it, they may be worth their current prices in a few years.

John Dorfman is chairman of Thunderstorm Capital in Boston and a syndicated columnist. He can be reached at jdorfman@thunderstormcapital.com.

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