The Market's Most Overvalued Stocks

Equity valuations have fallen back a bit so far in 2005, but price tags on most stocks are still on the steep side. (To see more on Morningstar's perspective on market valuations, check out our market valuation graph.) The median stock in our coverage universe of more than 1,500 stocks is now trading at a 10% premium to our estimate of its fair value. But there's a wide range of valuation levels around the median, with some stocks trading at discounts and others at steep premiums.

For this week's Five-Star Investor, we'll highlight stocks at the high end of the range: those trading at least twice as high as our estimate of the company's underlying fair value. About 80 stocks were pricey enough to pass this initial screen as of March 14, 2005. All of these stocks are expensive enough that we'd consider selling them, but we narrowed the list a bit further by screening for stocks lacking an economic moat and showing an above-average level of business risk. We'd be more generous with high-priced stocks that have the benefit of a moat or below-average risk, but in their absence, it's tough to justify holding the shares.

About 60 stocks made the final cut. About a third of those stocks were in the industrial materials sector, with many of the names hailing from the gold and silver, mining, oil/gas, and steel/iron industries. Many of these stocks have fared well thanks to the global economic recovery and strong commodity prices, but their operations tend to be fairly volatile because they're so leveraged to commodity prices. But several other sectors, including health care, technology, consumer services, and financial services, also showed up on the list.

At the most extreme end of the spectrum, several of these stocks have fair value estimates of zero, meaning that we think the shares are essentially worthless. While most companies should have some sort of minimum liquidation value, that's not always the case for companies that destroy economic value and have deeply negative cash flows.

Here are some of the more widely held stocks that passed the screen.

 Apple Computer (AAPL)
Price/Fair Value ratio: 111.95%
From the  Analyst Report: "The biggest risk facing Apple is its dependence on new product launches. Unlike most PC makers, Apple is expected to completely revamp its product lines every few years. These major product transitions entail substantial risks and costs."

 Seagate Technology (STX)
Price/Fair Value ratio: 130.88%
From the  Analyst Report: "Seagate continues to be hampered by challenges that have existed in the data-storage industry for years. Seagate must address competition from existing rivals, intense customer pricing pressures, and product development constraints, plus some company risks, before we would take a position in this stock."

 Inco 
Price/Fair Value ratio: 197.5%
From the  Analyst Report: "Although we think the fundamentals continue to look reasonably robust for commodity nickel, we don't like the subpar and often inconsistent returns on invested capital for most, if not all, base-metal miners. Characteristically, miners experience spats of stellar performance followed by inevitable dry spells. The industry is currently on an upswing, but now is not the ideal time to invest in mining shares, given the substantial premium one has to pay for the privilege of owning a proxy to the underlying metal, often with little or no current yield."

 Noble 
Price/Fair Value ratio: 120.48%
From the  Analyst Report: "Although we recognize that the company's returns on invested capital are good for a contract driller, they almost never top its cost of capital. Given Noble's risk, volatile earnings, and lack of a competitive advantage, the stock price would have to drop appreciably before we'd invest."

 Cameco (CCJ)
Price/Fair Value ratio: 173.38%
From the  Analyst Report: "Cameco is a dominant player in the increasingly attractive nuclear energy sector. Nevertheless, given the firm's exposure to volatile commodity prices and the public's sensitive appetite for nuclear-based power, we'd require a significant discount to our fair value estimate before investing."

 Sirius Satellite Radio (SIRI)
Price/Fair Value ratio: 972%
From the  Analyst Report: "Sirius is a startup with a history of burning cash. Its competition with XM is fierce, and there's no guarantee that both companies will survive over the long run. It's also possible that new technology could displace satellite radio."

To run this screen and see all the stocks that passed, click here. Note: The stocks mentioned above passed our screen as of March 14. The results of the screen may change due to daily price fluctuations or other factors. After clicking, you can save the search to use later by clicking the "Save Criteria" button in the bottom right-hand corner of the screen. (You will need to be logged in as a Premium Member to view and save the complete screen.)