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The Market's Most Overvalued Stocks

Fancy names can't make up for bad businesses.

Matthew Coffina, 09/16/2008

What's in a name? Probably not much, by most accounts. You wouldn't want a name to play a central role in your choice of a spouse, an elementary school for your child, or even a cocktail. Similarly, you shouldn't buy a stock just because you like the sound of the company's name. But sometimes, a name can convey some important information.

Legendary investor Peter Lynch loved companies with odd-sounding names, such as Consolidated Rock or Pep Boys-Manny, Moe & Jack PBY. That's because most individual investors wouldn't consider risking their capital in an unknown company with a phony-sounding name, and most Wall Street professionals would be too embarrassed to suggest such a stock to a client or boss. The lack of attention allows independent-minded investors to buy these obscure but wonderful businesses at discount prices.

On the other hand, some companies purposefully choose a name that sounds spicy and cutting-edge. Spending too much time on a fancy name could be an indication that management is less concerned with building a truly good business than with convincing investors they already have one. Worst of all, investors could take the bait, leading to overinflated stock prices. Investors' ears are much more likely to perk up when they hear a hot tip about CyberSource's CYBS eCommerce payment processing business than when they hear news of the latest price hikes at Potash Corporation of Saskatchewan POT (that is, until Potash Corp. kept churning out profits and the stock turned into a ten-bagger).

Below, we highlight five companies that, despite a carefully chosen name, have no economic moat and are trading at a significant premium to our fair value estimate.

CyberSource Corporation CYBS
Morningstar Rating: 2 Stars
Fair Value Estimate: $12
CyberSource provides electronic payment and risk management solutions to online merchants. Payment processing is a highly scalable business: the greater the volume of transactions processed, the lower the per-transaction cost. We think CyberSource lacks the scale to effectively compete with industry leaders like First Data, Global Payments GPN, and American Express AXP.

Emulex Corporation ELX
Morningstar Rating: 2 Stars
Fair Value Estimate: $10
Emulex designs electronic components that facilitate data transmission across computer storage networks. Strong demand growth and constrained supply over the last several years has led to healthy volumes and relatively firm pricing. However, we don't think economic profits can be sustained over the long run in the face of low barriers to entry, rapid product cycles, and emerging competition from new technologies.PAGEBREAK

Genpact G
Morningstar Rating: 1 Star
Fair Value Estimate: $9
Genpact is an offshore business process outsourcing firm. Outsourcing is a highly competitive industry with low barriers to entry, few switching costs, and high employee attrition rates. The benefits of outsourcing tend to accrue to the customers, who can select from multiple providers, terminate contracts at almost any time, and bring back-office functions back in-house.

InterMune, Inc. ITMN
Morningstar Rating: 2 Stars
Fair Value Estimate: $13
Biotech InterMune is focused on developing therapies for lung and liver disorders. The company's only approved product is seeing declining sales after it showed increased mortality in late-stage trials for a new indication. InterMune's pipeline drugs won't be launched for years, if at all, and the company is likely to require dilutive capital infusions to fund clinical trials in the meantime.

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