The 5 Most Expensive Stocks to Avoid Now

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Every Monday morning I sit down with Morningstar’s chief U.S. market strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research and a few stock picks or pans for the week ahead. Dave, the big thing on your radar this week is first-quarter earnings, but let’s back up a little bit and talk first about bank earnings that came out last Friday. How did things look and any surprises and key takeaways?

Dave Sekera: Good morning, Susan. Among the mega banks that reported on Friday, we had JPMorgan JPM, Citi C, and Wells WFC, I’d say results were just generally better than expected from market consensus. And I think even more importantly than that was that most of them increased their earnings outlooks based on higher net interest margin forecast going forward. Now, we did see some increases in loan-loss reserves, but really those increases just bring the banks back up to where they should be when compared to more of a historical average. At this point, I would say the banks really don’t look like they’re preparing for a large upswing in bankruptcies or defaults. I think that’s good news as far as trying to gauge at least their expectations of the economy for the next couple of quarters.

Now, among the regional banks, we did see results from PNC PNC, and probably the most important takeaway there was we didn’t see a real material change in their deposit base. That may be a good signal for some of the other regionals when they’re reporting. Other than that, with PNC, I’d say the results were actually slightly weaker than expected, but I don’t think they were weak enough that it would really materially change our view on the long-term earnings power for PNC. And then lastly with PNC, they did have actually weaker net interest margin assumptions, and that reduced their forecast growth rate. But I would say that when I take a look at that, and this is really just my assumption, is I think that the weaker net interest margin assumption on their part is really probably just an acceptance, that they’ll probably end up having to start paying a higher deposits going forward or higher interest rates on deposits going forward.

Dziubinski: Let’s look ahead a little bit, Dave. How do you think earnings season will shape up?

Sekera: Well, on a relative basis compared to what consensus is, I think the Q1 earnings actually probably will look pretty good. And so, when you think about over the course of the year, management teams, when they reported last year’s earnings in January and February of this year, I think most of them either had already guided down at that point, or at least they gave pretty conservative guidance thinking that the economy was probably going to be softer in the first quarter. But as you know, the economy has actually held up better than expected and better than what we expected, and I know our U.S. economics team at this point is expecting GDP in the first quarter for 2.6%. Really, the key for this quarter is going to be the outlook that management communicates to investors. I think the risk right now is depending on what management’s expectations are for the economy for the next quarter, we could see some management teams maybe guiding down more than what the market is expecting, and that, of course, could pressure those stocks.

Dziubinski: Dave, what’s your biggest worry this earnings season?

Sekera: Well, I would say in addition to the chance of reduced earnings guidance. One of the biggest worries I still have is among the regional banks, and we’re still waiting to see with the regionals, how much deposit flight that they had. And of course, depending on how much deposit flight they suffered, we could see a big selloff in some of those individual bank regional stocks. Now, the other part to that is depending on how much those deposits at those banks fell, it may force some of those banks to look to reduce the amount of loans that they have outstanding, and of course, that would then have a negative economic impact.

Dziubinski: Let’s pivot over to a new piece of research from Morningstar, and that’s your bond market outlook for this quarter. 2022 was of course a horrible year for bonds, but things improved during the first quarter of this year. How did bonds do and what drove that performance?

Sekera: Well, as you mentioned, after last year’s worst year ever for bonds, bonds are actually doing pretty well thus far this year. When I look at the Morningstar Core Bond Index, and that’s our proxy for the full fixed-income market, that’s up over 3.5% year to date, whereas you remember, it fell I think about 13.0% last year. And when I think about the returns this year, the amount that we had expected interest rates to rise last year, I think that’s behind us. And in fact, when you to take a look at the 10-year Treasury, that’s actually declined to a little over 3.50% right now. That was about 3.88% at the beginning of the year. I think the performance this year is really driven by a combination of two things: one, the higher yields that bonds now offer, plus a slight increase in long-term bond prices.

Dziubinski: Then Dave, what do you expect when it comes to Fed action and bond market performance this quarter and for the rest of the year?

Sekera: Well, when I break it down into the short term versus the long term. For short-term rates, I expect that those will probably stay where they are, stay relatively flat for now, but then we may see them start to fall toward the end of this year. Again, the Fed may have one more rate hike left in it, but then we think it’s going to pause thereafter. But thinking about the way the year may play out, we do project the economy is going to be soft in the second and third quarters, and we do expect inflation will continue to keep moderating. I think the combination of a soft economy and moderating inflation would give the Fed the room it would need to actually start cutting rates at the very end of this year.

Now, in the long-term part of the curve, the 10-year has already declined a little over 3.5%, and that’s our in line with our forecast for the average of this year. Although in 2024, we do think that long-term rates would continue to keep coming down, and I think our average forecast for next year is about 2.75%. From this point, I would say for the next couple quarters, I’d expect bonds will probably end up earning the current yields for the most part of the year, but we could see a little bit more upside in prices later this year or early next year’s interest rates start to come down, at least in our view.

Dziubinski: Dave, for investors who are willing to take on some credit risk for higher yields, how do corporate bonds look? Are they especially risky today if the economy softens?

Sekera: I think they actually look pretty valued to maybe even slightly attractive. And I do think that when you look at the amount of credit spreads, the amount that they pay over Treasury bonds in order to account for default risk and downgrade risk, I think that’s providing adequate returns for what we see going forward. Right now in the investment-grade market, the average spread on the Morningstar Corporate Bond Index is 133 basis points over Treasuries. And that’s almost 10 basis points higher than where it was one year ago. And the all-in yield on investment-grade bonds is about 5% right now. Then in the high-yield market, spreads are about 460 basis points, and that’s about 100 basis points higher than what we were at a year ago. And that currently yields 8.2%.

Just as a note that as the economy, or at least in our view, the economy probably softens the next couple quarters. Yes, there could be some short-term downward risk and maybe spreads widening out a little bit, but I know talking to our U.S. economist, even if there is a recession, he expects that it would be short and shallow. Overall, I think that means that there’s probably relatively limited risk for a lot of credit-rating downgrades, and we don’t expect to see a surge in default rates.

Dziubinski: Given all that, how should investors be thinking about their bond portfolios today?

Sekera: Between the higher yields that we’re getting now, wider corporate credit spreads, I’m actually pretty comfortable extending duration back out probably into that seven to 10-year range. Whereas if you remember last year we were advising investors to stay more into that shorter-duration range and more in that three-year area.

Dziubinski: Let’s move on to the stock picks portion of our program. But this week you brought us some stock pans or stocks to avoid because they’re so overpriced relative to what we think they’re worth. Your first stock pan this week is the most overvalued stock our analysts cover, and it’s Squarespace SQSP.

Sekera: Squarespace is trading at a 65% premium to our fair value estimate, and it’s currently rated 2 stars. Now, the reason it’s actually 2 stars right now instead of 1 star is because the Uncertainty Rating is currently Very High. That allows a stock to trade up to 75% above fair value before it drops into that 1-star territory. But as you noted, that’s the one that we see as being most overvalued across those 700 and some stocks that we cover that trade on U.S. exchanges. Now, Squarespace is a pretty interesting company. It does have some very good growth dynamics. They provide website-building software tools and hosting services, primarily for small, growthy startup businesses. And the company has grown quickly. But over time, we do believe that additional competition will limit future growth. And as such, we think the market is really just being overly optimistic regarding its long-term growth rate and margin expansion.

Dziubinski: The second most overvalued stock that Morningstar’s coverage list is a bigger name, Oracle ORCL.

Sekera: It is a relatively a larger company, and it’s also one that we rate with a narrow economic moat. And that moat is based on switching costs, and those switching costs are really just because it’s difficult and risky when companies do try and switch off of Oracle platforms. And this is one, we actually do forecast a pretty strong top line growth rate, looking for a 7% compound annual growth rate over the next five years. We even expect pretty strong margin expansion to 39% from 26% over the next five years. But again, when we compare our valuation to the market, we think the market is just pricing in too high of a growth rate and even greater margin expansion than what we’re expecting. Right now, Oracle is trading at a 40% premium to our fair value and is currently rated 1 star.

Dziubinski: The next stock on the list of overpriced pans is actually a stock that made headlines last quarter with a tremendous near 90% return, and that’s Nvidia NVDA.

Sekera: Yeah. Nvidia stock has a history of just swinging wildly back and forth from undervalued to overvalued and back and forth. In fact, Nvidia was actually rated 2 stars at the beginning of last year, at the beginning of 2022, and that stock fell 50% last year and actually dropped all the way into the 4-star territory by the end of last year. As you mentioned, the stock has skyrocketed this year, and I think a lot of that is because the market is very excited about their opportunities in artificial intelligence. And again, we agree with the market. The company does have very strong presence in making semiconductors for AI applications. And again, this is a good example of just a high-quality company, one that we rate with a wide economic moat, but the valuation has just gotten to be too high. Right now, that stock does trade at about a 30% premium to our fair value and is rated 2 stars.

Dziubinski: Now, the fourth most expensive stock we cover is Trade Desk TTD. Tell us about that one.

Sekera: Well, and this is one I hadn’t heard of before. I actually had to do a little bit of research and learn this one myself. Trade Desk is interesting. It runs a platform that helps advertisers and ad agencies find and purchase digital ad inventory. And it has grown very rapidly over the past couple of years since it went public. And we do think it is starting to develop a network effect, but at this point we don’t have enough confidence that they’re really going to be able to create that competitive advantage. At this point, we don’t rate the company with an economic moat. It’s currently rated two stars and it does trade at a 30% premium to our intrinsic valuation.

Dziubinski: And then the final stock on our list of overpriced stocks is Cadence CDNS. This looks like a good example of where we like the company, but the share price is just too rich.

Sekera: Cadence makes software for semiconductor companies, and that software then helps those companies design and analyze new semiconductors. Now, it’s been a strong performer year to date, think it’s up over 30 some percent. And investors, again, do expect this will be a good one that will benefit from growth and semiconductors as they do design the software that’s used in order to be able to make those artificial intelligence chips. Again, we agree the firm has got a long runway of growth. It’s going to benefit from the emergence of AI, but the market, I think, has just gotten ahead of itself at this point. This is a 2-star-rated stock, and it trades at a 33% premium over our valuation.

Dziubinski: Well, thanks for your time this morning, Dave. Be sure to join. Dave and I live on YouTube every Monday morning at 9 a.m. Eastern, 8 a.m. Central. And while you’re at it, subscribe to Morningstar’s channel. Have a great week.