Whatever You do, Stay Away from These 2 Stocks
September 16, 2011By: David StermanArticles RSS feedPrintPrint

In a challenging market, investors seek out reasons to sell holdings just as often as they search for new stocks to buy. Of course, it's not a decision made in a vacuum. Your buy and sell decisions are often influenced  by what others might be doing. Good stock picking (and unloading) is usually a function of staying one step ahead of the crowd. So it's important to know that before long, a crowd of investors will be set to possibly unload large blocks of stock on the open market, forcing their prices down quickly.

The stocks in question are initial public offerings (IPOs) from earlier this year. These companies' founders, financial backers and key executives were all prohibited from selling stock when their company first went public. But after 180 days, they get the green light, known as the "lock-up expiration." This means any company that went public in late March or in April could soon be hit by a wave of insider selling.

Here are nine names to watch. If you own any of them, then you may want to get out before insiders do. If you are thinking about buying them, then it pays to wait until the insider selling has run its course. And if you're looking for stocks that might be ripe for a short, then add these names to your research list.

 
 
Of course, certain IPOs have been badly beaten up and insiders are likely to sit tight, after watching their "paper gains" vanish. A good example of such an IPO is Sequans Communications (Nasdaq: SQNS), a provider of wireless systems software. The stock busted out of the gate, moving up 100% from mid-April to late May when investors saw it as a great way to play the smartphone revolution. But after reporting its first quarter as a public company, investors quickly realized near-term growth would be elusive and reliance on just one key customer was too risky. Shares began plunging and they've been in freefall ever since, now trading 75% below that late May peak of $19.

If insiders actually decide to unload the stock at these depressed levels, then value investors may finally pounce. The company has $70 million of fresh IPO cash (almost half of the current market value) and recent losses are likely to soon morph into small profits.

Other stocks would also be quite appealing after a downdraft, but you should wait to see what insiders will do when they're free to sell. I'm a fan of Zipcar (NYSE: ZIP), especially because an increasing number of my friends rave about the car-sharing service. The IPO looked a bit rich to me in the spring at $30, but steady selling pressure has made it much more reasonably valued. The stock now trades at roughly $19.

Too rich for retail?
At a time when many retailers are struggling -- and sporting low price-to-earnings (P/E) ratios to boot -- it's surprising to see health and vitamin retailer GNC Holdings (NYSE: GNC) trading for almost 18 times projected profits. Why the relatively high multiple? It's because GNC delivered solid second-quarter results in late July -- its first quarterly result as a public company. Same-store sales rose a hefty 11% from the year-ago period, thanks to new merchandising initiatives such as "ready-to-eat" meals.

But it's far too soon to call this a solid growth story, because same-store sales growth had been fairly anemic in recent years and is likely to cool back below 5% again next year, according to Goldman Sachs analysts. They rate shares as "neutral," noting shares are fully-priced at more than 20 times projected free cash flow. With a full valuation in place, insiders have ample incentive to lighten their load.

Misplaced euphoria
Perhaps the most vulnerable stock in this group is Argentina-based Arcos Dorados (Nasdaq: ARCO) ("Golden Arches," in Spanish), a major McDonald's (NYSE: MCD) franchisee in Latin America. I had a fairly bullish outlook on the company in May, but a 35% upward move since then, combined with a broader market going the other way, has now made this stock ripe for a pullback. Investors have been bidding up shares -- which now trade for nearly 40 times projected 2011 profits -- after seeing same-store sales are rising quickly.

In August, each McDonald's outlet the company controls saw revenue rise by an average of 20%. This has brought momentum investors into the stock in recent weeks, even as the broader market has slumped. But are 20% comps likely to continue? Of course not...

This is really a play on Brazil, because the country accounts for roughly 70% of the company's earnings before interest, taxes, depreciation and amortization (EBITDA). The Brazilian economy has been on a tear in recent years and, although I'm quite bullish on the country in the long-term, near-term growth looks set to cool in tandem with the global economy. Between locked-up insiders and momentum traders, a recipe is in place for selling pressure to beget even more selling pressure.

Risks to consider:  Lock-up expirations are just one factor to consider. You need to examine the fundamental trends for these companies and simply consider the possible post-IPO as a clear headwind for shares in the near-term.

Action to Take --> There's a simple rule of thumb in play. The better the stock has done since its spring IPO, the greater the temptation for insiders to take profits. GNC Holdings and Arcos Dorados, for example, have done remarkably well when you consider the tough market environment.
This may be enough grounds for insiders to lock in profits at this point. Sequans and Zipcar, on the other hand, may turn out to be nice pick-ups for a portfolio in need of a reasonably-priced growth stock.

David Sterman
Contributor, SmallStocks.com
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