Spring-Cleaning Your Portfolio

Ah, the wonders of spring. Despite the brisk weather here in Chicago, it’s a great time to clean up the yard, straighten the closets--and clear the detritus from your portfolio. While most people look for stocks to jettison toward the end of the year, it’s not a bad idea to take a look at your holdings at other times during the year, either. There’s no point in continuing to hold stocks with poor prospects if you can replace them with something more promising. (For more on this topic, see Morningstar.com Editor in Chief Haywood Kelly’s recent article, "When Quick Selling Makes Sense".)  

I polled our analysts to find stocks we would seriously consider selling. Although any sell decision has to be based on individual circumstances, you’re usually better off avoiding stocks that are clearly overvalued or those that have deteriorating growth prospects. Below, we list some of the stocks that we think are significantly overvalued and might be good candidates for the trash heap.

 Krispy Kreme Doughnut 
Yes, we love the company’s products as much as everyone else does. But even if the company can pull off tremendous growth by opening new franchises, it’s tough to justify the stock’s pudgy valuation. In his valuation model, Morningstar stock analyst Harry Milling assumes that Krispy Kreme can generate 30% annual sales growth over the next five years, and steadily improve profitability. But the company won’t be able to generate above-average profits forever, and even with aggressive growth assumptions, we come up with a fair value on the stock that's roughly half of where it’s currently trading. (For an opposing view, read Ron Baron’s recent shareholder letter for Baron Growth (BGRFX).)

  Cintas (CTAS)
Although Cintas has a strong position in the uniform-rental business, Morningstar stock analyst Dan Schick argues that the current stock price doesn’t leave enough of a margin of safety. Now that Cintas already dominates the uniform-rental market throughout the United States, future growth opportunities will be harder to come by. Part of the company’s past growth also has been driven by acquisitions, which also won’t be as easy to duplicate in the future. With growth possibly slowing and the stock richly valued, investors probably can find better opportunities elsewhere.

 Imclone Systems 
Imclone shares have dropped about 44% so far in 2002, but we think the stock is still far too risky. The company botched the application process for Erbitux, a new drug for colorectal cancer; as a result, the product’s launch has been delayed. We also have serious qualms about the quality of Imclone’s management team. It’s not clear if Imclone was entirely forthright with development partner Bristol-Myers Squibb (BMY), and huge stock sales by the COO and CEO shortly before the Food and Drug Administration’s negative decision also raise doubts about management’s integrity. Despite the potential scientific promise of Erbitux, we think investors should steer clear.

 NVIDIA (NVDA)
NVIDIA has been tanking lately, but we think the stock remains risky. Although the company’s graphics chips have driven surprisingly strong revenue gains, there’s always the danger of technological obsolescence. In addition, much of the company’s future growth hinges on demand for Microsoft’s (MSFT) highly popular Xbox game console. Add in an SEC investigation about the company’s expense recording practices, and we think the stock’s current price is still too steep. 

 Sepracor 
Drugmaker Sepracor sports a $1.5 billion market cap, but it has only one proprietary product on the market. That might not be a big problem if it had more top sellers in the pipeline, but Sepracor’s development-stage products have suffered numerous disappointments. The Food and Drug Administration nixed its new allergy drug, and Sepracor also had to stop development on an improved version of Eli Lilly’s (LLY) Prozac. Morningstar stock analyst Todd Lebor values the shares at only $5 apiece--miles below the current price in the $20 range.

 Charles Schwab (SCH)
We've been positive on Schwab in the past, and even owned it in Morningstar StockInvestor's Hare Portfolio. Recently, though, we decided to pull the plug and sell the stock. Our rationale was simple: We no longer felt comfortable betting on a quick uptrend in market trading volume. In addition, we think it’s unlikely that Schwab will be able to return to the 20%-plus revenue growth rates it enjoyed in the second half of the 1990s. We sold the stock when it was trading at $14.43 per share, or more than 30% above our $11 fair value estimate. 

Etc.
Be sure to check out our Conversations board today for an open forum with Gary Kelly, CFO of Southwest Airlines (LUV). You can post your own questions in the Ask the Expert area.