Investors nervous about the sustainability of the current market rally--which entered its seventh year this past March--may take some comfort in the fact that stocks, in aggregate, don't appear to be egregiously overvalued to Morningstar's equity analysts today. According to our Market Fair Value graph, the median stock in our global coverage universe was trading a hair below our analysts' estimate of its fair value as of mid-June 2015.
That doesn't mean stocks are cheap, by any stretch, but it is a bit lower than the median price/fair value earlier this year, before interest-rate-related worries began to roil sectors like utilities and REITs. That said, Morningstar analysts' bottom-up research does point to pockets of overvaluation. As of mid-June, the health-care, communication-services, industrials, and technology sectors were the most overvalued, based on Morningstar analysts' research; the solar, semiconductor, airlines, pay-TV, and health-plan-provider industries looked particularly expensive. (If you can find a discernible theme there, please let me know.) Drilling down to the company level, 103 stocks in Morningstar's coverage universe were trading 25% or more above our analysts' estimates of fair value in mid-June--and 27 of those were trading a whopping 50% or more above our analysts' estimates of fair value.
To review, analysts estimate companies' future cash flows to arrive at companies' fair values. If the fair value estimate for the stock--based on the analyst's estimate of the company's intrinsic worth and the number of shares outstanding--is $100 per share but the stock is trading at only $90 per share, then its price/fair value ratio is 0.90. If the stock is trading at $110 per share, its price/fair value ratio would be 1.1. A price/fair value ratio below 1 suggests the stock is trading at a discount to its fair value, while a ratio above 1 suggests it is trading at a premium to its fair value.
To take a look at which stocks look especially overvalued right now, we used Morningstar's
. We screened for companies that were trading 50% or more above our analysts' fair values as of June 16; to help surface the most widely owned names within that subset, we further screened for companies with market caps of $5 billion or higher.
Sixteen companies fit the bill. The health-care sector is disproportionately represented on the list, with five companies trading 50% over their fair value estimates. Two,
None of the companies on the 15 most highly overvalued list has a wide moat currently; seven have narrow moats and another eight have no moats. Three of the companies on the list have fair value uncertainty ratings of medium, meaning that our analysts have a reasonably high degree of confidence in their ability to predict the company's future cash flows and, in turn, to determine its fair value. The other 11 companies on the list have high fair value uncertainty ratings, meaning that there's a great deal of potential variability in the companies' future cash flows and, in turn, their fair values. They could surprise on the upside and grow into their currently lofty valuations, but they could also experience unexpected negative developments that could push their valuations lower in a hurry. (Lawsuits, government intervention, and bankruptcies are examples of such negative factors; this article does a deeper dive into the connection between fair values and fair value uncertainty ratings.)
The fact that many of these companies have high fair value uncertainty ratings means that this list shouldn't be construed as a shopping list for short-sale candidates. While current valuations suggest that new purchasers of these companies are apt to be disappointed, short-sellers would come in for pain if any of these companies were to surprise on the upside.
Here's a closer look at three of the companies that made the list as of June 16, 2015. Premium Members can click
to view the complete list.
Humana Price/fair value: 1.77 | Fair value uncertainty rating: High Moat: None | Morningstar Rating: 1 star Given lofty valuations, discussion of industry consolidation and the ongoing implementation of the Affordable Care Act, and significant recent volatility, senior analyst Vishnu Lekraj believes a lot could go wrong for investors in the managed-care industry. One of two managed-care organizations on our list of most overvalued companies, Humana has ably navigated many of the challenges and changes resulting from the ACA, in Lekraj's view. But he believes that Humana's reliance on Medicare Advantage plans makes it vulnerable amid a push for lower payment rates for government-sponsored medical programs. He has a similar set of concerns for Cigna and views it as just as overvalued as Humana.
Hyatt Hotels Price/fair value: 1.53 | Fair value uncertainty rating: Medium Moat: None | Morningstar Rating: 1 star A lot has gone right for Hyatt: Senior analyst Dan Wasiolek notes that the company has reported healthy revenue per available room and room growth, and he thinks that the firm's brands, including Hyatt Place, are well situated for the next generation of travelers. He also believes that the hotel cycle should remain positive for the next two to three years--a tailwind for lodging companies like Hyatt. But valuation is the fly in the ointment; Wasiolek believes the market is more than pricing in all the good news without duly considering what could go wrong. Topping Wasiolek's list of threats for Hyatt and other traditional hotel chains is the rapid uptake of independent hotels and private home and vacation rentals, especially by younger travelers.
PerkinElmer Price/fair value: 1.58 | Fair value uncertainty rating: Medium Moat: Narrow | Morningstar Rating: 1 star PerkinElmer, a medical and environmental testing and diagnostics company, is one of eight companies on the list with a narrow moat, conferred by its diagnostics business. Regional director Alex Morozov notes that its prenatal, neonatal, and maternal screening unit is the firm's crown jewel; not only do such tests enjoy broad use in the U.S., but they're also seeing widespread adoption across the globe. That said, he believes the firm's valuation is lofty, particularly given the firm's "never-ending business restructuring." Given that negative foreign-currency swings have recently cut into the firm's results, he also thinks macroeconomic forces could be a headwind.
Data as of 6/16/2015.