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Beware These Wall Street Darlings

Wall Street likes these stocks. We don't.

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Morningstar currently rates about 60 stocks as 1 star, meaning we think they're at least 30% overvalued. Among these companies, you'll find quite a few that Wall Street loves, at least judging by the number of "strong buy" ratings they receive.

There's a common reason for the disagreement, aside from the fact that "strong buys" still flow like tap water on Wall Street: While Wall Street focuses on earnings, we focus on stock valuation. Here's what I mean by that (admittedly gross) generalization. If a company's profits are rising, chances are Wall Street analysts will recommend the stock. They cherish companies that meet quarterly earnings targets, for example, and will often judge a management team largely on the basis of whether it can meet those quarterly targets. If it doesn't, then the management team "loses credibility." And if the company misses its targets and the stock is in free fall, eventually it's sure to attract a lot of "hold" ratings. 

But when everything's going well, stocks tend to become expensive. And that's where the discrepancy between Wall Street recommendations and Morningstar's star ratings often arises. When we run some of these stocks through our discounted-cash-flow (DCF) models, we get fair values way below the current stock prices. That's why they receive low star ratings. The companies may be great. But the stocks aren't.

Haywood Kelly, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.