A friend of mine recently asked whether he should short a certain senior care stock that had seen a nice run-up in price to a level that some would say was at least a few years ahead of its time from a price to earnings ratio basis (or any other basis). I told him of an old rule of thumb on Wall Street, which was never to short a rising stock. By shorting a stock that keeps on rising, there are obviously forces driving that rise that have little to do with your belief that the stock is overpriced. And while eventually your short position may pay off, the better likelihood is that you will close the short position to minimize your loss, as the stock continues to rise, well before the expected (looming) drop. The problem is that most short sellers are fully hedged, either locking in the gains on their existing holdings or hedging convertible bonds, and are not just willy-nilly shorting stocks because they expect them to drop in value.
In looking at the senior care sector, the bull market in assisted and independent living properties, as well as publicly traded stocks, over the past few years has been well documented. But the question keeps on popping up, How much higher can prices go? All of the AL/IL stocks hit 52-week highs in the first quarter of this year, and this was after all but one jumped by 45% to 113% in 2005. By any standard, the performance and valuations are unusual, especially when considering that half the companies have not yet reported consistent positive earnings.
Has the market peaked? It is hard to tell, but anecdotally, in the facility acquisition market it would appear that the buying frenzy of the past 12 to 18 months has taken a breather. Either that, or the supply of high-end portfolios coming to market has dwindled. The actual M&A activity is expected to be robust through the end of the second quarter, but most of those properties went to market last year and are just now closing. Prices are still high, and cap rates remain low, but the buzz of last year can hardly be heard. That is not necessarily a bad thing.
Regarding stock prices, since the end of the first quarter, every AL/IL stock has dropped in price, ranging from just over a 1% decline to more than 11% in the past two weeks. While this is not the end of the world, it may signify a new resistance level that will not be broken for several weeks without a better earnings performance, a major rally in the overall markets or both. To put things into perspective, even with the recent minor drop in share prices, since the beginning of 2005 American Retirement Corp. is up 103%, Capital Senior Living is up 93%, Emeritus Assisted Living is up 62% and Sunrise Senior Living is up 60%. Last, but not least, Brookdale Senior Living, which has been publicly traded for only five months, has doubled in price since the IPO last November. At some point, investors will demand current performance to justify these lofty prices, and at the first sign that things may not be as promised, we could hear a loud thud, followed by another.
Getting back to my friend who wants to short a stock or two, my advice is that it is still too early to short, but it may also be too late to buy.
Related links:
For more articles on the senior care acquisition market, see Index links for The SeniorCare Investor
Get the inside scoop on senior care M&A at The SeniorCare Investor
Database of health care M&A transactions, including senior care acquisitions
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