3 Stocks to Sell and 3 Stocks to Buy in March

Susan Dziubinski: Hi. I’m Susan Dziubinski with Morningstar. Every Monday morning I sit down with Morningstar Research Services’ chief US market strategist Dave Sekera to discuss what’s on his radar this week, some new Morningstar research, and a few stock picks or pans for the week ahead. Good morning, Dave. On the earnings radar this week, we have a few overvalued technology names reporting. Stocks that look priced to perfection from our perspective. The first is CrowdStrike, which is ticker CRWD. We’ve talked about this cybersecurity play on the show before, and the stock has really shot up since then.

Dave Sekera: Good morning, Susan. We first recommended CrowdStrike on our show back on Feb. 6, 2023. At that point in time, the stock was a 4-star-rated stock. Since then, it looks like that stock is up 188%, and that now puts it into 2-star territory. I still like the long-term fundamentals of the cybersecurity industry. I still see a lot of positive aspects to it, but like many of the stocks in the cybersecurity space, it’s just risen too far too fast according to our valuations. In fact, if you look at some of the comparables here, like Zscaler ZS reported last week, that was a 2-star-rated stock going into earnings. That dropped 10%. The week before that was Palo Alto PANW. That also was a 2-star-rated stock when it went into earnings. That one I think dropped around 25% after its earnings report. In this case, I probably think there’s more downside risk here than there is upside potential.

Dziubinski: Got it. There’s also Broadcom reporting this week. That’s ticker AVGO and that’s another richly priced tech stock that’s rallied substantially over the past year riding that AI wave of investor interest.

Sekera: Again, when we look at these stocks a year ago, a lot of them were very undervalued. This one was a 4-star-rated stock in December 2022. It’s up 150% since then. That’s now a 1-star-rated stock and trades at a 44% premium to our fair value. Now, we do expect that AI will be a material driver of their business. Applications like the large language models do require advanced network switching, and we think Broadcom’s chips are probably best of breed for that. We do take that into account in our financial assumptions and our projections, but when we look at this, since December 2022, we’ve increased our fair value by 55% as well. We’re up to $970 a share from $624. But I think the takeaway here is, again, the stock has just risen too much too far.

Dziubinski: Now Oracle, which is ticker ORCL, also looks overpriced. But in this case, the stock hasn’t shot out the lights by any stretch.

Sekera: It’s still a 2-star-rated stock, trades at a 35% premium to our fair value. Now, it is a company we do rate with a narrow economic moat. We do think it’s one of the best providers for database technology as well as ERP [enterprise resource planning]. And when I take a look at our forecast here, we’re forecasting a five-year revenue compound annual growth rate of 8%. We’re still looking to expand to 36% in 2028 from 28% in 2023. But essentially it just looks like the market is expecting even more growth than what we’re currently projecting. And we do think that cloud competition will probably provide additional headwinds in the future. Specifically, reading the research here from Julie [Bhusal Sharma] who covers the stock for us, she’s concerned that Oracle might be losing market share against other new database types that might be better suited to the cloud business.

Dziubinski: Dave, are there any under-the-radar names reporting this week where there might be an opportunity for investors?

Sekera: The other one I’m going to be watching myself is going to be Brown-Forman. That ticker is BF.B. Now that stock, when I look at the historical charts here, it rose too high in 2020 and it went up to 2 stars, but it’s been on a pretty strong long ward downtrend since then. But it does look like it may have bottomed out here in January at a 4-star rating. Now it has bounced. It’s now a 3-star-rated stock, and it’s only a 4% discount. But I do think this might still be an opportunity to buy a pretty high-quality name that when you look at it, rarely trades much below our fair value estimate. Now, I’m not a Jack Daniels guy myself, but they do have the best-selling American whiskey brand in the world. It’s a company we rate with a wide economic moat and a Medium Uncertainty. And the company has been successful in expanding into both premium as well as super premium segments as well as into the faster-growing ready-to-drink category.

Dziubinski: Also this week we have Fed Chair Powell speaking before Congress over a couple of days this week, and investors will, of course, be listening. What will you be listening for?

Sekera: He’s speaking both Wednesday and Thursday at the semiannual Monetary Policy Report to Congress. And there are really three areas I think to focus in on. First is going to be inflation expectations. I’d like to hear some more details on what the Fed wants to see before they start to begin lowering the federal-funds rate. When I look at our numbers here, the Morningstar economic team is still very comfortable with their projection that the rate of inflation is going to continue to keep slowing over the next couple of months and actually through the rest of this year and into next.

Second, I want to hear his view on the economy. The economy actually has been holding up better than expected, even better than what we’ve expected. In fact, we just bumped our 2024 GDP forecast to 2.0% from 1.8%. So again, how long can the economy continue to keep performing better than expected in the face of what we consider to be restrictive monetary policy? And then lastly, any commentary he might have on the soundness of the regional banks in light of their commercial real estate exposure. For example, here in early February, New York Community Bank NYCB did announce some big hits in its commercial real estate exposure. The bank is back in the news again. They announced some problems with their internal controls. They replaced their CEO. That stock, it did sell off last week, and I also noticed that it did send the bonds tumbling down as well.

Dziubinski: And then the last thing on your radar this week, Dave, is the nonfarm payroll number that’s coming out on Friday. What’s this number indicate and why is it worth watching?

Sekera: It’s worth watching because depending on where it comes out, it could move the markets up or down. But I’m looking at it as an indication of the strength of employment, an indication of economic performance. But really more importantly, I think the market is looking at it as an indication for the outlook for wage growth. So again, if we have too tight of a labor market, that could lead to high wage growth. And again, while that’s good for those individuals who can get paid more, it is bad for our outlook for inflation. The concern there would be if we do have too tight of a labor market, that could potentially lead to more of a wage-price inflation spiral.

Dziubinski: Got it. Moving on to some new research from Morningstar, and we’ve got a lot of ground to cover on this front this week. Let’s start with Snowflake, which is ticker SNOW, which is the stock we’ve talked about before on the show as an AI play. Last week, Snowflake reported earnings, provided an updated forecast, and announced its CEO is leaving. It’s a lot of news, Dave. Recap it for us.

Sekera: Well, and I’ve got to admit, I was very disappointed by the earnings release and the news here. So if you remember, we actually recommended this stock on one of our shows in October of 2023. I think the stock at that point in time was $150 and change. We thought this was going to be a good second derivative play on artificial intelligence. The stock did trade up, got over I think just $230 a share, and that put it right about at our fair value just prior to earnings. Now following earnings, we did cut our fair value by about 20% down to $187 a share, which is where the stock is trading right now. So I guess the good news is if we did buy back in the $150 range, it’s still up on the trade, but this is just a really messy situation. The company did provide revenue and margin guidance below what the market expected and what we expected, and even worse, they also pulled their long-term guidance.

Dziubinski: What changed from our perspective? Was it sort of that news of pulling the guidance? Did the surprise departure of the CEO play a part? What contributed to the change?

Sekera: I pulled up our financial model that we had both before as well as after the earnings release. And the things that lowered the fair value the most is we did lower our long-term revenue growth rate down to 23% from 34% previously. And then we also pushed back our operating margin expansion expectations. We’re only forecasting a 1.1% operating margin in 2028. That’s down from 6.4% beforehand. When I think about the situation now, what I’m really trying to figure out is, is the company just using this quarter, using the management change as really kind of an opportunity to lower their guidance for the company, kind of kitchen-sinking it this quarter to make it easier for the new management team to outperform going forward? Or is this more indicative of some deteriorating underlying fundamentals? And after talking to our team, we think it’s actually more the latter.

Dziubinski: What do you think about the surprise departure of the CEO? It seems like it did catch everybody off guard, right?

Sekera: There’s really not much to say here. It’s just never a good sign when you have an unplanned replacement of the CEO.

Dziubinski: Let’s pivot over to some other new research and that’s Morningstar economist Preston Caldwell’s new forecasts. He’s made some tweaks. First, he and you mentioned this earlier, he bumped up his GDP forecast for 2024 and then he ratcheted back expectations for 2025 and 2026. What do the reforecasted numbers look like and why the change?

Sekera: The economy’s still been holding up better than expected. I think the economic indicators we’ve seen here in January and February are looking pretty good. I mean, not ridiculously strong, but enough that we did increase our GDP forecast for the full year up to 2.0% from 1.8%. But as you mentioned, he then actually lowered his expectations for 2025 and 2026. We’re currently looking for 1.5% GDP growth in 2025 and 2.6% growth in 2026. That’s a slight decrease from 1.7% and 2.8%, respectively. So I think when I’m looking at these lower long-term forecasts and reading through Preston’s research, I think essentially what he’s doing here is he’s just accounting for the delayed impact to the demand side of the economy from the currently restrictive monetary policy.

Dziubinski: Looking at his inflation forecast, it doesn’t seem like that one changed that much. Morningstar is still looking for inflation to fall back to the Fed’s 2% target in 2024. How do Morningstar’s inflation expectations differ from that of the markets?

Sekera: It’s lower than what the market is expecting. So if you look at the consensus expectations right now for inflation, they are looking for it to stay higher. The market, I think, is at about 2.4% right now versus our 2.0% forecast.

Dziubinski: And then finally, let’s talk about Morningstar’s interest-rate expectations. Here, we’re still looking for interest-rate cuts this year, but we’ve pushed those rate cuts back to May or June from March. Update viewers on our interest rate expectations for 2024 and beyond.

Sekera: Whether it’s the May meeting or the June meeting that the Fed does start to cut the federal-funds rate, we do forecast that once they begin to cut, they’re going to cut at every single meeting thereafter for the rest of the year. What that means is if they start cutting at the May meeting, we’d expect the federal-funds rate at the end of the year to be in that 3.75% to 4.00% range. But if they don’t start cutting until the meeting thereafter, it means at the end of the year, we’d be in that 4.00% to 4.25% range. But I would also note that we did reduce how much we expect our long-term interest rates to subside over the course of this year.

We had expected the 10-year US Treasury to average three and a half percent. We do expect it now to average 3.50% this year and 2.75% next year. You know what, I’m actually looking at my numbers here wrong, Susan. Let me restate that. We have reduced our forecast for the long-term rates. We had expected the 10-year to average 3.50% this year and 2.75% next year. That new forecast now is for 4.00% this year and 3.00% next year. Sorry about that.

Dziubinski: It’s all right. Based on our updated economic and inflation forecasts and current stock market valuations, what does Morningstar think of the market today?

Sekera: We just published our regular monthly outlook, and that is available now on Morningstar.com. So the broad US market right now is trading only a couple of percent above our fair value. So, in my mind, it doesn’t put us into that overvalued territory just yet, but when I look at the market and the charts, I think the market is starting to feel a little stretched here in the short term. And historically, if you look at the market valuation compared to our valuation, since the end of 2010, it’s only traded at this much of a premium or more 25% of the time.

Now, we do break our valuation down a couple of ways, both by the Morningstar Style Box as well as by sector. I’d note at this point we do think the core and growth categories, which of course have surged higher last year and this year, are now trading at premiums. They’re trading at 3% and 4% premiums over our fair value. And the value category lagged last year; it’s still lagging a bit this year, but according to our numbers, that’s still trading at a 9% undervaluation compared to where we think it should be. Then looking by capitalization, large caps have done very well this year. Those are overvalued. We still like mid-cap and small cap, especially the small-cap space where that’s trading at a 19% discount to fair value. And then by sector, both technology and industrials trading at 8% premiums to fair value, putting those in the overvalued category. Consumer defensive also now starting to get kind of pricey, trading at a 5% premium. And then where we see value: communications is still the most undervalued sector at a 12% discount. That’s followed by real estate at an 11% discount and then by utilities at a 10% discount.

Dziubinski: Dave, when the market trades at, you referred to “at fair value,” what might long-term investors expect in terms of market returns ahead?

Sekera: For longer-term investors, it means that over time I would expect to be able to earn the weighted average cost of equity of the market. Now of course there’s always going to be a lot of volatility both to the upside as well as to the downside. But if you hold through that volatility over the longer term, I would expect to get 8% to 9% type of returns. But, of course, it’s those periods of volatility when the market is either overvalued or undervalued that you can manage the exposure of your portfolio either above or below kind of what your target rates are to try and take advantage of that natural market volatility to try and add some additional upside.

Dziubinski: In your March stock market outlook, you say that now is a good time to begin to invest in contrarian plays, but you say that’s not just for the sake of being a contrarian. Unpack that for us.

Sekera: Maybe I’m a little on the early side to this one, but based on our valuations, I do think now’s a good time to start breaking away from the herd. And just to give you a bit of background thinking about the trend that we’ve had for the past 15 to 16 months, in our 2023 outlook, we did note that both growth stocks, as well as technology stocks, were very undervalued. Technology was one of the most undervalued sectors at that point in time. And then also coming into 2023, when you look in the “Mag Seven” stocks, six of those seven were either 4- or 5-star-rated stocks. Now since then, the growth category is up. Tech’s up even more. And when we look at those Mag Seven stocks, three of them are now overvalued, three are fairly valued, and only Alphabet GOOGL is undervalued.

Taking a look at it by growth, the growth categories are at a 3% premium, and tech is at an 8% premium. While not the most overvalued that each of those has traded, I do think it’s a good time to take some profits in those areas. Of course, the question is, if you take profits, well then what do you do? Where do you put that money? So, I started looking for some of those areas. Some of those stocks specifically that have underperformed this market rally, are currently unloved by the market, and are, in our view, undervalued. We looked across all of those sectors and stocks and essentially tried to find where have they lagged, the broad markets to the upside, where do we see a lot of negative market sentiment, and which ones are now trading at a good margin to safety from their intrinsic valuation.

Dziubinski: In your outlook, you outline three good places for investors to look for these contrarian plays. As you say, these places are all underperforming, unloved, and undervalued. The first is real estate. Recap what’s been going on in the sector and why you like it.

Sekera: Commercial real estate has got to be probably the most hated asset class across the Street right now. First, there is still a huge amount of uncertainty regarding valuations for urban office space. And secondly, real estate has been adversely affected by the increase of interest rates over time. And both of those have brought valuations down across the entire real estate sector. The real estate index did drop 25% in 2022. It only rose 2% last year, and it’s actually down again 2% this year. Personally, I’d still steer clear of urban office space, but other areas we do think have gotten pulled down with that urban office space too much, especially those real estate sectors that we think have more defensive type of characteristics. And then lastly, I would note the Morningstar US economic team does project interest rates will decline later this year. We’re looking for the entire yield curve to decline over the course of this year and next. And I think those declining interest rates would then provide a good tailwind for the real estate sector.

Dziubinski: You also suggest investors look for contrarian ideas in the utilities sector. Why?

Sekera: It’s just a combination of three things: one, valuation, two, fundamentals, and three, interest-rate expectations. Now utilities were only up 1.6% in 2022. They were down 7.0% last year in 2023, and now they’re down again over 2.0% year to date. That puts the sector now at a 10% discount to our fair values. And fundamentally, when you talk to our equity analysts, they think the utilities space is as strong as they’ve ever seen it. They see a long runway of growth here for the transition into renewable energy. We’re seeing a lot of government investment in the electrical grid infrastructure. That should all provide some pretty good growth for the utilities space over the next couple of years. Plus, we do think that the tailwind behind declining interest rates will be positive for them over the next few years.

Dziubinski: And your last contrarian sector is energy. Explain the dynamics of what’s been going on there and why it’s undervalued.

Sekera: When I look at energy and look at our oil and gas stocks, what’s embedded in our models is that we project oil demand should peak later this decade and then start to gradually decline thereafter. We also project a midcycle oil price of $55 a barrel for West Texas. So, again, we’re not looking for really a lot of upside here from a fundamental perspective, but even based on those assumptions, the energy sector is trading at a large discount to fair value. The downside here would be if demand falls faster than what we currently expect. However, I don’t think that we’re being all that aggressive. I think we’re probably one of the more conservative forecasts on the Street for demand. And of course the other downside would be if oil prices were to fall more than what we’re currently projecting.

Now to the upside, if those assumptions that we currently have in our models do come to fruition, energy is one of the more undervalued parts of the market today. And, of course, if oil prices stay higher or if demand is better than what we expected, I think there’s a lot of upside leverage here. And then lastly, I do think the energy stocks could also benefit if we see a rotation in the value stocks, higher demand for higher dividend-paying stocks. And then lastly, I do think the energy also acts as just a good natural hedge in your portfolio, not only for inflation but for any other additional geopolitical risk.

Dziubinski: Let’s move on to the picks portion of our program. You’ve brought viewers, three stocks to sell and three stocks to buy based on your March stock market outlook. Heading into March, as you mentioned earlier, growth stocks are overvalued and tech stocks are even more overvalued. So, your stocks to sell are all pricey tech or tech-related stocks. The first stock to sell is Meta META. A wide economic moat for this company, recently announced it’ll be in paying a dividend, yet it’s a sell. Why?

Sekera: I think Meta is emblematic of the market performance that we’ve seen since the market bottomed out at the end of October 2022. Back then, I mean you almost couldn’t give that stock away. Now it was a 5-star-rated stock at that point. It was trading at a 60% discount to fair value. And that stock has now skyrocketed, I think about 400% since then. And it’s not like we stood still, we actually increased our fair value by over 50% over that same time period as well. So just like the pendulum swung too far to the downside back then, we just think the pendulum is now swinging too far to the upside.

And lest you think our forecast might be overly conservative, when I pull up our model here, we are projecting revenue to grow at a compound annual growth rate of over 10% over the next five years. We are looking for the operating margin to expand from 35% last year all the way up to 41% by 2028. So, essentially earnings of $17.70 this year growing all the way to $28.36 in 2028. And those assumptions still put us in that 2-star category as the stock trades at a 26% premium to that intrinsic valuation.

Dziubinski: Wow. Now you also think Arm ARM is a stock to sell. Arm went public last fall and the stock has really shot up since then, and SoftBank still owns about 90% of the company, and that lockup period is ending soon. So just sounds like there might be some red flags around this stock right now.

Sekera: According to our equity research team, Arm is probably one of the most overvalued stocks under our coverage right now. So as you mentioned, it did go public last September. That stock is up 123% since then. But as you mentioned, only 10% of the company was sold publicly at that point. So, the other 90% is still in private hands. You have to think about the technicals there. That current valuation is really only based on 10% of the company trading in the public markets.

It looks like that lockup period ends here maybe in mid-March. So, we could see a lot of that locked-up supply come into the markets, and that added supply could provide some price pressure to that stock. Now, taking a look at our model here, revenue, we expect a five-year compound annual growth rate of 18%. Essentially we’d be looking for revenue to go from $2.7 billion in 2023 up to $6.2 billion by 2028. We’re looking for the current operating margin of 25.2% in 2023 to go all the way up to over 40% in 2028. Right now, our earnings per share is $1.14 this year. That puts the company now at 125 times this earnings report, and at $2.56 of earnings in 2028, according to our forecast, you’re still paying 55 times five-year forward earnings at this point on that stock.

Dziubinski: And then the last overvalued stock to sell is Palantir PLTR. The stock looked really cheap a while ago, but it’s completely shot out the lights during this past year, again, riding that AI wave. Talk about it.

Sekera: Palantir has just been a very highly volatile stock over the last couple of years. Originally, it was one of those disruptive tech stock plays. It shot up in 2020. I think the stock peaked in 2021. It was well in 1-star territory. Since then, it’s dropped over 80%, putting it down into 5-star territory. It then bottomed out at the end of 2022. Looks like it was trading with a six-handle back then, and now it’s back up to $25 a share. So it’s currently rated 2 stars. Taking a look at our model here, we do forecast a pretty high revenue growth rate. We’re looking for a compound annual growth rate of 21% over the next five years. To put that in context, we’re modeling revenue to go from $2.2 billion in 2023 up to $5.7 billion in 2028. We’re looking for operating margins to double. We’re going to look at forecast earnings of $0.33 a share here in 2024, going up to over $0.60 by 2028. So if you’re buying that stock today, you’re paying 75 times this year’s earnings and 40 times 2028 earnings.

Dziubinski: Let’s move on to some stocks to buy instead. You have three contrarian stock ideas for investors in March, one from each of the out-of-favor sectors we talked about earlier in the show. Your first pick is from the real estate sector, it’s AvalonBay communities AVB. Tell viewers about it.

Sekera: AvalonBay focuses on owning large, high-quality properties and has a portfolio of 281 apartment communities, over 87,000 units. They’re also currently developing 18 additional properties with another 6,000 units. So again, that multifamily space has been under intense pressure. We did see New York Community Bank take significant hits there. They did call out their multifamily exposure there as well. But I do think that what happened with New York Community Bank is different than what we’re going to see with AvalonBay. Our REIT team actually did recently sharpen their pencils. They took a fresh look at our entire real estate coverage here. They did lower their fair value on AvalonBay, a little bit under 9% to $213 a share from $233. But even after lowering our fair value there, it’s still a 4-star-rated stock, trading at a 16% discount, and has a 3.8% dividend yield.

Dziubinski: Now, your second contrarian stock pick is a utility. It’s Duke Energy DUK. A pretty big player among electric utilities and has a pretty good-looking dividend yield, too.

Sekera: The dividend yield there is 4.5%. The stock’s currently a 4-star-rated stock. Trades at a 19% discount. And a lot of things to like here. We do rate the company with a narrow economic moat; it does have a Low Uncertainty Rating. I think the question here is why do we think this is a contrarian play? And, in our view, we think the market doesn’t fully appreciate the constructive regulatory environments that Duke operates in. And we think that Duke just has a long runway of growth opportunities in its regulated businesses. And so right now, we think it’s actually one of the most undervalued utilities under our coverage.

Dziubinski: And then your final stock pick this week is from the energy sector. It’s APA APA, it’s a name we’ve talked about before on the show. Remind viewers why you like it as a contrarian play.

Sekera: It’s a 5-star-rated stock. Trades, I think just over a 50% discount to our intrinsic valuation. The company has a 3.3% dividend yield. Now, it is a company, we do rate with no economic moat, but I’m looking at this one as a catalyst-driven situation. So APA does have a joint venture with Total TTE in Suriname, and it seems like evidence here points to potentially a very large oil play that’s kind of in the discovery stages right now. And we do think it’s very likely that at least one or more of these discoveries will progress then to the development stage. I do have to caution people, none of these have been officially sanctioned by the companies just yet. The final investment decision on whether or not they’re going to move forward and develop these plays won’t be until toward the end of this year.

But if they do move forward, our energy team thinks that the first oil production could begin in 2028. And according to Stephen Ellis, that would just be a game changer for this company. That could double the company’s production over the course of the next 10 years. Yet, according to our valuations, it doesn’t seem like the market has included this probability into the stock price just yet. So, at this point, it actually kind of looks like a free option to us.

Dziubinski: Well, thanks for your time this morning, Dave. Viewers interested in researching any of the stocks that Dave talked about today can visit Morningstar.com for more analysis. We hope you’ll join us again next Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this video and subscribe to Morningstar’s channel. Have a great week.