Dave Sekera: Hi, I’m Dave Sekera, chief U.S. market strategist with Morningstar Research Services, filling in for Susan Dziubinski this week.
Half the battle in long-term investing is identifying high-quality companies whose stocks are trading at a significant margin of safety from their intrinsic value.
The other half of the battle is avoiding those stocks that are overvalued, or in today’s case, selling those stocks that have run up too far in price that they have become overvalued and overextended.
5 Stocks to Sell Before Labor Day
First up today is Hess. Hess is one of those situations in which it has some of the best assets, with great growth prospects, and deserves a high valuation—but in our view, the market valuation is just way too high as compared to our assessment of its net asset value.
For example, when we look at different valuation metrics in this case, such as enterprise value/EBITDA (where EBITDA is an approximation of free cash flow) the stock is trading at an EV/EBITDA of well over 9 times. Hess’ next-closest competitor is closer to 6 times. So our fair value actually places an EV/EBITDA at about 7 times, higher than its competitors, but still well below the current market valuation.
Technology stocks, of course, have just soared thus far this year and Oracle has not been left far behind. In fact, Oracle’s stock has surged over 40% this year to new all-time highs, and now trades at about a 50% premium to our valuation. This places the stock in 1-star territory. The company actually has posted very good performance, but our equity analyst has concerns that there is much more limited upside over the long term to the cloud infrastructure market than what the market is currently assuming.
Also in the technology sector is Cadence Design Systems. Fundamentally, Cadence is doing very well. It posted strong second-quarter results and, based on the elevated demand for hardware solutions, management even guided to a stronger second half of the year.
In our forecasts we already incorporate that secular trends toward artificial intelligence, 5G communications, and cloud computing will actually continue to accelerate, and that Cadence will benefit from both the rising intricacies of chip designs and the increasing complexity of various end markets. Yet even after incorporating the acceleration of these trends, the stock is now trading at about a 40% premium to our valuation, as it’s risen 40% thus far this year. As such the stock is currently rated 2 stars.
Next up is Old Dominion Freight Line. Old Dominion provides less-than-truckload carrier services. Its business has been under pressure as trucking companies are adversely affected by retailer destocking and a pullback among U.S. industrial end markets.
Yet Old Dominion’s stock has surged over 40% this year, with the preponderance of that gain coming in just the past two months. The reason for that surge is the market’s hope that Old Dominion will gain a significant amount of market share following the bankruptcy of its competitor Yellow Trucking. In our projections, we do forecast that it will gain a meaningful amount of those shipments, and we have boosted our short-term forecast for volume recovery. However, in our view, the market is overestimating the amount of long-term free cash flow growth.
Lastly is Eli Lilly. It’s been in the news a lot this year. Its type 2 diabetes drug, Mounjaro, has been found to help in weight loss.
In our forecasts, we already include an above-consensus projection for peak sales for this drug, yet in our view, the market is paying way too high a valuation for this growth. We rate the stock with 2 stars and it trades at about a 50% premium to our valuation.
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Morningstar sector directors Brian Colello, Damien Conover, and Dave Meats along with senior analyst Matthew Young and equity analyst Julie Bhusal Sharma contributed to the research behind this segment.
Watch “3 Top Stocks for the Next 10 Years” for more from this series.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.