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It's Time to Take Profits on These High-Flying Stocks

By Frank Curzio, editor, Phase 1 Investor
Friday, October 8, 2010

On Wednesday, one of Wall Street's darlings had a terrible day.
Shares of Equinix (EQIX) fell 32% after the company reported weaker than expected earnings results. Equinix is a data center leasing company. It helps its customers save money while outsourcing the location of their servers.
After blowing away earnings estimates quarter after quarter, the company said it needed to provide discounts to its customers to secure long-term contract renewals. This is a fancy way of saying its business is becoming "commoditized," and its growth is slowing.
Investors ran for the exits.

Four sell-side research firms downgraded Equinix following earnings. The other 17 analysts covering the company lowered estimates, including Stifel Nicolaus – who placed the company on its "Select List" one week before the earnings announcement.
We saw a similar trend two weeks ago. Software maker Adobe Systems lowered its earnings estimates for next year. Like Equinix, shares surged into its quarterly earnings report. After results fell short of expectations, the stock plummeted 20% in one day.
There are several other expensive technology companies I'm cautious on...
2011 price to earnings
2011 price to EBITDA
12-month gain
Salesforce (CRM)
Amazon (AMZN)
Netflix (NFLX)
F-Five (FFIV)
If earnings announcements from these companies do not live up to expectations, they could also sell off in excess of 20%.
You are probably familiar with most of these names. They are mentioned on CNBC every day. They are also trading near 52-week highs. Gains over the past 12 months range from 94% to 238%. The S&P 500 is up only 8% in the same timeframe.
What you may not know is, these stocks are trading at more than 35 times next year's earnings. Yes, earnings do matter!
Many investors have tried shorting these stocks in the past. The result has not been pretty. My advice is not to short – since the short ratios on these particular stocks are very high. In other words, any good news could result in a short-squeeze, pushing shares considerably higher.
Instead, I suggest you take your profits and run. Here's why...
Listed in the second column in the table above is each company's price to next year's EBITDA ratio. EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It's also a measure used by buyout specialist.
In the large-cap space, buyouts usually happen at prices between 10 and 12 times EBITDA. For example, Intel is buying internet security firm McAfee for 11 times next year's EBITDA ($7.7 billion). Six months ago, oil services giant Schlumberger paid 10 times 2011 EBITDA ($11 billion) for competitor Smith International.
This multiple could be higher depending on the company, its patents, and its technology. However, the companies mentioned above are trading at more than 20 times next year's EBITDA. Keep in mind, takeovers are offered at a premium... If one of these companies were to receive a takeover offer, it would have to be much higher than 20 times EBITDA.
Looking at the potential risks vs. the rewards, it doesn't make much sense owning any of these companies into earnings season. These companies are already expected to beat earnings estimates. If earnings fall short of estimates, you may lose more than 20% of your investment in 24 hours. In fact, even if one of these companies fell 20%, it would still be considered expensive.
After a great run, I think it's time to cash in on these high-flying names.
Good investing,
Frank Curzio

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Market Notes
Natural gas breaks to 12-month low… weekly data shows healthy inventories.
Gold, silver, and copper pull back as U.S. dollar bounces off lows.
Asia up... Hong Kong (EWH), Malaysia (EWM), and Taiwan (EWT) funds touch fresh 52-week highs.
Real estate uptrend continues… Kimco, Ventas top long list of REITS notching fresh highs.
Market Watch
Symbol Price
S&P 500 1165.15 +0.6% +9.4%
Oil 36.15 +2.0% -1.4%
Gold 131.66 +1.0% +27.0%
Silver 22.73 +3.2% +29.7%
US-Dollar 77.40 -0.1% +2.0%
Euro 1.39 +0.1% -5.8%
Volatility 20.71 -3.9% -14.4%
Gold Stocks 521.26 +1.3% +15.9%
10-Year Yield 2.38 -0.8% -27.0%

World ETFs
Symbol Price
USA 116.54 +0.6% +9.3%
Canada 28.91 +1.3% +11.0%
Russia 20.17 +0.6% +3.8%
India 38.43 +1.8% +29.4%
Israel 16.22 -0.7% +15.3%
Japan 10.23 +0.5% +2.8%
Singapore 13.54 +0.1% +25.5%
Taiwan 13.71 +0.3% +11.2%
S. Korea 55.68 +0.4% +21.4%
S. Africa 68.88 +1.3% +21.6%
China 44.40 +1.2% +3.9%
Lat.America 51.66 +1.9% +15.3%

Sector ETFs
Symbol Price
Oil Service 115.79 +2.0% -6.2%
Big Pharma 65.68 +0.3% +0.1%
Internet 63.74 +0.3% +22.7%
Semis 13.34 -0.2% +10.1%
Utilities 31.85 +0.3% +9.6%
Defense 17.54 +0.5% +9.2%
Nanotech 9.33 +2.1% -11.4%
Alt. Energy 9.93 +0.1% -8.1%
Water 17.12 +1.8% +3.5%
Insurance 15.56 +0.9% +11.5%
Biotech 19.92 +0.9% +18.2%
Retail 17.77 +0.7% +13.5%
Software 22.57 +0.7% +16.4%
Big Tech 49.75 +0.7% +17.8%
Construction 12.30 +1.2% +2.0%
Media 12.68 +1.8% +16.4%
Consumer Svcs 62.21 +0.7% +17.5%
Financials 53.15 +0.2% -0.2%
Health Care 63.80 +0.3% +8.7%
Industrials 59.38 +0.8% +17.9%
Basic Mat 67.91 +2.2% +20.2%
Real Estate 54.32 +0.1% +28.7%
Transportation 83.52 +1.0% +19.7%
Telecom 21.87 -0.1% +18.2%