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Analyst darlings get no love

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Tuesday, July 22, 2014, 12:01 a.m.
 

Wall Street analysts love American Tower REIT Inc. I do not share their enthusiasm.

The same goes for American Water Works Co., ServiceNow Inc., Envision Healthcare Holdings Inc. and Gray Television Inc.

These companies are doing well. But I feel the analysts are too ready to extrapolate their success into the future.

I view the business world as resembling a Ferris wheel. Companies at the bottom may rotate to the top as they develop products or change leadership. Companies at the top may succumb to increased competition, lured into their industries by the winners' high profit margins.

That's one reason I prefer out-of-favor stocks. When all of Wall Street likes a stock, I usually don't.

Each of the companies mentioned above has debt that exceeds stockholders' equity. It's not a big problem now, when interest rates are low and the companies are doing well. But if circumstances change, the debt could become burdensome.

Last year

This is the third time I have highlighted five stocks that Wall Street loves and that I dislike. The first time (May 2012), the analysts' picks failed to match the Standard & Poor's 500 Index. The second time (July 2013), the analysts' picks did very well indeed.

The five stocks from last July returned 45.3 percent including dividends, versus 18.5 percent for the S&P 500. That's egg on my face.

The success of the analysts' darlings from last July was driven in large part by a 108 percent gain in Targa Resources Corp. (TRGP), a Houston company that transports and processes natural gas.

Other big gains among the stocks I disdained were a 53 percent advance for Royal Caribbean Cruises Ltd. (RCL) and a 37 percent return for Las Vegas Sands Corp. (LVS). The only stock that declined was Oxford Industries Inc. (OXM), down less than 1 percent.

I believe that the investment climate in the past 12 months has been favorable to growth and momentum. Interest rates were strikingly low, and American economic growth was accelerating. I suspect the next 12 months will be more kind to value approaches.

Here are five new stocks that analysts love to pieces. I doubt they will do as well as hoped.

American Tower

Nineteen analysts have “buy” ratings on American Tower (AMT), with nary a “hold” or “sell” in sight. The analysts expect earnings to grow 25 percent in 2015.

High expectations, however, are difficult to meet, let alone exceed. The debt level at American Tower is, well, towering — more than three times equity. And the stock sells for 63 times trailing earnings (33 times estimated 2015 earnings), leaving little margin for error.

American Water Works

Providing water to about 1,500 cities and towns in 16 states, American Water Works (AWK) is one of the few publicly traded plays on the water-scarcity theme. But let's remember that water utilities are still regulated utilities.

Of the 17 analysts who follow the company, 16 rate it a “buy.” But the shares seem fully valued to me at 22 times earnings.

ServiceNow

Based in Santa Clara, Calif., ServiceNow (NOW) provides cloud-based information-technology services. That's a hot area, and investors have bid Ser-viceNow shares up to red-hot multiples: 259 times next year's expected earnings, 17 times sales and 20 times book value (corporate net worth per share).

In my opinion, investors are likely to be burned. That could be embarrassing for the 20 analysts who have “buy” ratings on the stock.

Envision Healthcare

The tally on Envision Healthcare Holdings (EVHC) is 14 “buys” and two “holds.” The company, which is based in Greenwood, Colo., provides ambulance services and physician staffing.

It has been growing rapidly, and could get a boost from the Affordable Care Act. More insurance means a higher percentage of patients will pay Envision's bills.

The stock price is 169 times recent earnings and 24 times the earnings analysts expect for 2015. In my experience, valuations in that range rarely lead to profitable investments.

Gray Television

Gray Television (GTN) of Atlanta owns several dozen TV stations in 34 metropolitan areas. Only three analysts follow it, but all three rate it a strong buy.

I have concerns about Gray's balance sheet. Debt is more than $800 million, which is between four and five times stockholders' equity.

I am also skeptical about the price-earnings ratio. The average PE over the years is about 15. The market is now near 19, and Gray is twice that, at more than 39.

Note that all ratios in this article are as of July 11, 2014. I was on vacation the week of July 14.

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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