Despite falling stock prices over the last three months, these names are still too richly valued.
Many investors relished the pullback in stock prices last quarter--not so much because they liked the red ink splashed across their portfolios, but because they saw the decline as an opportunity to buy on the dips.
And that isn't necessarily a bad idea. Buying undervalued stocks is like getting a dollar for 50 cents. It improves your chances of getting a decent return, gives a larger margin of safety if something goes wrong, and is much preferable to piling in to very expensive stocks. And today, even after the recent bounce-back, stocks still look reasonably undervalued as a whole. Our equity analyst staff reckons that the median stock in our coverage universe is trading at only 85% of its fair value at the moment.
But that doesn't mean indiscriminate buying of equities on a dip is a good idea, either. Oftentimes stocks are selling off for a good reason. Over the last few months, there have been very real fears about European sovereign debt, weak economic indicators in the U.S., and the potential of slowing growth in emerging markets. A blowup in Europe could have a real impact on the future earnings power for all sorts of firms. The decline in some share prices could be due to a real decline in value. And there are cases where stocks go from ridiculously overvalued to merely overvalued. In other words, just because something has sold off a lot doesn't mean that it's cheap.
To uncover these mirages in the value desert, I used Morningstar's Premium Stock Screener to find shares that have fallen in value over the last three months but that are still rated 1-star. Below are three stocks that passed.
3-Month Return: -7.35 | Economic Moat: None | Fair Value Uncertainty: High
We believe there is risk to expanding the product portfolio [to footwear], as it could have a dilutive impact on merchandise margins, given that footwear generates lower margins than those of Under Armour's core merchandise apparel. We also think the company will have trouble making products that command enough pricing power to drive superior gross margins relative to its peers. Increased product development, marketing, and international expansion also could weigh down operating margins over the short run. However, we believe these investments, if made carefully, will better enable Under Armour to grow over the long haul.
3-Month Return: -20.07 | Economic Moat: Narrow | Fair Value Uncertainty: High
Our biggest concern about LinkedIn is that its user base will feel exploited and stop using the network. Online advertising is an important component of the company's revenue stream, and management has instituted some initiatives to increase traffic and page views at the website. It is not clear to us that individuals want to spend more time at LinkedIn, and the value may only be in the contact database and resume maintenance capabilities. If the website changes dramatically to become more of a content destination site, users may stop using LinkedIn.
The industry is young, but we are very positive on the prospects for LinkedIn. Still, even good companies should be bought for less than they are worth.
3-Month Return: -15.26 | Economic Moat: Narrow | Fair Value Uncertainty: Medium
Although Salesforce.com's market share could approach or exceed that of its traditional on-premise software rivals, the same cannot be said of its profitability. A critical determinant of the company's profit potential is its ability to achieve scale in marketing expenses, which presently account for more than 46% of revenue. Large deals involving many subscribers are key to realizing the benefits of scale, as they tend to lower the acquisition cost per subscriber. Profitability could also be helped by reducing customer attrition, which has been averaging in the midteens. Custom solutions built on the Force.com platform implicitly increase customers' investment in Salesforce.com's service, thereby potentially increasing customer stickiness. The firm's recently launched Chatter Cloud is another attempt to increase stickiness by spreading the usage of its service across more users. Nevertheless, while the company's profit levels should continue improving, high customer acquisition costs will keep operating margins well below those of traditional on-premise competitors.