Year-End Pariahs

 | Dec 19, 2012 | 11:30 AM EST
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Coming into December, everyone was worried about the fiscal cliff and the economic implications for the stock market, myself included. There were also concerns about selling stocks in front of changes in the capital gains tax rate. Many pundits suggested lightening up or even getting out of the market in front of what was sure to be certain collapse. It has not happened.  The market has not merely climbed a wall of worry, it has sprinted up the fiscal cliff like Usain Bolt reaching for the tape. In the past month, the stock market has shot up by more than 6% as Santa Claus showed up right on time for Wall Street, giving many hedge fund managers a chance to make their numbers for the year.

One could spend a lot of time wondering what happened to the certain decline in the market. The fiscal issues still loom and, despite all the rhetoric and promises, we are not any closer to an actual solution. Earnings were lackluster at best and economic indicators are still very mixed. Despite all this, sellers never showed up and buyers have had a memorable Christmas party so far this December. I have no idea why all the excitement but, fortunately, I am sticking with buying cheap and selling dear as my market-timing skills are somewhat suspect.

I do know that after a sharp rise like this, many stocks become overvalued and are at risk for a fall. I won't predict markets, but I will suggest that every stock can hit a price that is too high and is too risky for most investors. A simple approach of looking for high-multiple momentum stocks with a high degree of insider ownership and insider selling has side stepped many of this year's momentum disaster like Netflix (NFLX) and Green Mountain Coffee Roasters (GMCR). When a stock has staged a strong move, insiders have started to sell and the exit door is crowded with institutions, it is probably time for most to snake out the door with their gains to avoid a permanent loss of capital.

I ran a screen this morning looking for stocks that meet those conditions and might be best to sell or avoid as we head for the end of the year. One stock that has had a huge run this year is Eagle Materials (EXP). Coming into this year, no one really expected a company that makes gypsum wallboard, aggregate and cement to have a strong showing, but this company has benefited from improvements in housing and construction markets. Earnings and revenues have been much stronger than the always highly accurate analysts expect, and the stock has shot up by more than 150% in the past year. Institutions have been piling in as they try to anticipate a stronger housing recovery in 2013.

Insiders are taking the opposite approach and sneaking out the back door as the stock has reached premium valuation. The stock now trades at more than 50x earnings and 5x sales and book value -- a rich valuation for a building-material company in any part of the economic cycle. Several insiders, including CEO Steven Rowley, seem to agree they have sold more than $70 million of shares in the open market as in the past 90 days. Eagle is a solid company but it's probably time to step off this train before it runs out of track.

Apparently, the officers and directors of both major credit card companies are not as confident that we sail up the cliff into the first quarter of next year. Both Visa (V) and MasterCard (MA) have seen large clusters of insider selling in the past few months. These are both great companies and, between them, they dominate their industry. But both trade at premium valuations for consumer-based companies and have heavy institutional ownership. They have had great runs and it is probably a good idea to join the insiders in sneaking out a bit early.

Lamar Advertising (LAMR) had a great year in 2012 and the stock price has responded nicely. The shares are up more than 60% over the past 52 weeks as earning shave been better than expected in a soft economy. The shares have also been given a boost by the company's announcement that it was considering converting to a real estate investment trust. Institutions currently own more than 90% of the shares, so this is a very crowded trade. In recent weeks, several insiders, including CEO Kevin Reilly, are ringing the bell and booking gains. With a triple-digit price-to-earnings ratio and almost 5x book value, investors might be wise to join them.

The key to long-term success in the stock market is sometimes the ability surviving long enough to reach the long term. Avoiding or eliminating situations where valuations are high, institutions own too much and insiders are heading out the door can help investors increase their odds of survival and success.

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