It’s Time to Sell These 4 Surging Stocks

With the S&P 500 surging roughly 25% in the past 12 months, it’s been a great time to have full exposure to the stock market. Yet market strategists continue to remind investors that they should only expect 6% to 8% gains annually from your stock investments. This helps explain a growing sense of caution and restlessness in the market. After all, we’ve been climbing up the “Wall of Worry” as the twin fiscal messes in Europe and the United States threaten to push our respective economies into recession. As I noted a few weeks ago, “the market can go down a lot faster than it goes up.”

That’s why it’s imperative you continue to play defense and build some short positions into your portfolio, or at least avoid overvalued stocks. I went in search of stocks in the S&P 500 that may have peaked and may be vulnerable in a weaker market. These stocks have all risen at least 25% during the past six months, but are expected to post slow (or negative) profit growth in 2013. 

Here are four that stand out…

1. Tesoro (NYSE: TSO)
Oil refineries (which convert crude oil into gasoline, diesel and other distillates) have seen their stocks catch fire this year as industry profit margins have moved up. The credit goes to expanding profit spreads as industry refining capacity moved down to the level of demand. Shares of this refiner have been perhaps the greatest beneficiary as it rose a hefty 69% during the past six months.

As a result, this stock more than reflects the good times at hand. For example, of the eight refiners Goldman Sachs follows, Tesoro has the highest 2013 price-to-earnings (P/E) ratio of the group, at 8.6. Yet Tesoro’s operating cash flow and net income are expected to actually decline in 2013, as the 2012 environment for this and other refiners may be hard to replicate. Analysts expect earnings to fall by more than $1 per share in 2013 to around $5.56. This stock has made a great run, and now looks to be a prime “sell” candidate.

2. Lennar (NYSE: LEN)
This homebuilder’s six-month gain of 49% is surely impressive. The fact that shares are up more than 125% during the past 52-weeks is even more impressive. As is the case with many homebuilders, Lennar has begun to aggressively expand again, building homes on acquired properties that had been moth-balled during the Great Recession. Yet investors may be confusing supply with demand. Just because home builders are set to build a lot more homes in coming quarters doesn’t mean sales will rise at a commensurate pace. In fact, these homebuilders run the risk of creating another glut, as they still have to contend with hundreds of thousands of existing homes that are already for sale, or will soon appear on the market as sellers test the waters again.

At the end of the day, home builders are really asset plays. The fact that this stock is now worth more than two times tangible book value tells you investors have already paid up for a very robust future that may take its sweet time in getting here.

3. Amgen (Nasdaq: AMGN)
In recent years, this once-hot biotech play has looked more like a slow-growing Big Pharma stock. Sales grew at a double-digit pace annually up until 2007, hitting $14.8 billion. Yet four years later, they had risen to just $15.6 billion, representing a compound annual growth rate of just 1.5%. 

But in recent quarters, management has decided to raise the company’s profile by boosting research and development efforts on new drugs, dividend hikes and share buybacks. That’s helped fuel a 33% gain in the stock during the past six months to an all-time high.

Trouble is, Amgen’s new drugs will only help take up the slack as growth slows for existing drugs –especially its key ESA (erythropoiesis-stimulating agents) drugs Epogen and Aranesp. Merrill Lynch’s analysts looked out during the next five years worth of cash flow and figures that the sum should equate to a stock price of just $83, below the recent $89 trading range.

4. Merck (NYSE: MRK)
Amgen looks like a cheetah compared to this drug giant. Sales are expected to fall $500 million this year to around $47.5 billion and even further by 2013 to about $46 billion. That’s what happens when key drugs start to lose steam. For example, Nasonex, Cozaar/Hyzaar and Singulair, all of which are generating more than $1 billion in sales this year, are expected to see sales decline in 2013.

So why have shares moved up 23% in the past six months? A rising stock market gets some of the credit. You can also point to tightening cost controls that should keep profits from falling at the same rate that sales are. Still, this is a stock that used to sport a high single-digit P/E multiple that now sells for nearly 13 times projected 2013 profits. That’s the highest forward multiple for Merck in five years, and this stock is quite vulnerable when investors look to lock in profits on recent gainers.

Risks to Consider: As an upside risk, these stocks can keep levitating if the market moves higher, though there are surely more appealing value-oriented plays if you are bullish about the months ahead for the market.

Action to Take –> A series of short-term drivers has boosted these stocks, from a spike in oil refining margins to an increase in the dividends, to a sense that the housing market will soon catch fire. But as you dig deeper into these drivers, then it’s hard to see how they will fuel even further upside in 2013, considering future gains are already baked in to these stock prices.