What to Sell

This is one major reason I'm constitutionally unsuited to be a bear.

Imagine if you'd been short the market, rooting for a big drop, and now cranky about the money you've lost while everyone else has cause to celebrate. Who'd want you at their holiday table?

But once thanks are given, it may well be time to take action. With the Nasdaq Composite at 2450 this week, the average is approaching my latest selling threshold of 2515, when it may well be time to lock in some of these recent gains. That means the Nasdaq has gained almost 25% since the summer correction, much faster than I would have guessed.

As it turns out, I've already consulted my list of overvalued stocks, based on the formula I've described that combines recent price appreciation with the price-to-earnings growth, or PEG, ratio. Since writing my column two weeks ago about the virtues of the proposed CVS/Caremark drug distribution merger, I've been itching to buy CVS (CVS) shares. This is one special situation I feel strongly about, which doesn't mean I'm right. But you've got to act on your convictions. There's nothing worse than having a good idea, watching it pan out, but reaping no reward because of inaction. Since my recommendation, CVS shares have gone nowhere, but the broad market has kept ascending to new highs. Last week I decided there was no point in waiting for a substantial correction. Even though I'd never increase my exposure to stocks in a market this frothy, it's OK to add positions as long as I sell something else. That's what led me to my list of overvalued stocks.

In checking options prices for CVS, I was pleased to discover that there was only a very small premium if you're willing to buy in-the-money calls. With CVS at $29, I bought the January 2008 calls with a strike price of $25 for just over $5. When I checked today, with CVS shares trading near $28, the spread had widened slightly, and those calls were quoted at $5.70. Even so, that's less than a 10% premium. The January 28 calls with a strike price of $20 had an even lower premium. To pay for those calls, I simply sold calls on stocks that looked pricey, and offered big call premiums. This is the same kind of stock I'll be looking to sell if the Nasdaq surges past my selling threshold.

So what was on the list? At the very top is SonicWALL (SNWL), which makes network-security software, firewalls, and email-security software. It's already up nearly 50% this year — not a bad showing, but more to the point, it boasts an off-the-chart PEG. Don't ask me why. All I can say is that if I owned this stock (I don't) I'd be running for the exits.

Also rounding out the top 10 are such well-known names as Qwest Communications (Q), Sun Microsystems (SUNW), and Akamai Technologies (AKAM). Akamai has nearly tripled this past year. My advice: Don't be greedy. These are prime candidates for profit-taking.

(When you run the data to produce your own overvalued list, your results may differ, since they change constantly with shifting prices. I ran this screen last week.)

Not surprisingly, there were plenty of commercial real estate investment trusts on the list. Notwithstanding Blackstone's proposed $20 billion buyout of Equity Office Properties (EOP), the data support my view that many of these REITs are overvalued. In this latest deal, my money would be with Sam Zell, a shrewd investor who I suspect smells a market peak in this sector. Some other familiar names on the list (in descending magnitude of being overvalued) include Krispy Kreme (KKD), Celgene (CELG), AMR (AMR), Merck (MRK), Marvel Entertainment (MVL), Dillard's (DDS), Comcast (CMCSA), and Campbell Soup (CPB).

Conspicuously absent were energy companies (there were plenty on the list earlier this year) and financial concerns. And, needless to say, drugstore chains like CVS.

So enjoy the holiday, enjoy friends and family, get some rest, and come back refreshed. New opportunities beckon.