The Five Most Overvalued Stocks Today
The stock market may be poised to take a big fall soon. Last week, the NASDAQ Composite Index hit a record high despite mounting evidence that COVID-19 cases are on the rise. If the economy shuts down again, most stocks will take a hit.
Some stocks are more vulnerable than others to a rapid selloff. Most at risk are tech stocks trading at high valuations. Many of them have rallied strongly since the stock market bottomed out three months ago.
Last week, I ran a series of technical and fundamental screens to determine which stocks appear most overvalued. Specifically, I looked for U.S. exchange-traded stocks that satisfied all of these criteria:
- Price-to-Sales (P/S) ratio greater than 4.0
- Price-to-Earnings Growth (PEG) ratio greater than 3.0
- Price-to-Book (P/B) ratio greater than 3.0
- Price-to-Cash Flow (P/CF) ratio greater than 20
- Debt-to-Capital (D/C) ratio greater than 50%
- Profit Margin (PM) less than 15%
- Fast Stochastics Overbought (FSO) indicator greater than 80
What I am looking for are stocks that appear to be grossly overvalued on a technical basis while possessing weak fundamentals, too. Of the thousands of stocks that trade on U.S. exchanges, only five of them met all of my requirements.
The Fatal Five
In no particular order, below are the five companies that possess a potentially fatal combination of high valuation metrics and poor fundamentals. For that reason, they appear most vulnerable to a stock market selloff.
YETI Holdings (NYSE: YETI) – Outdoor gear marketer.
P/S = 4.0, PEG = 3.3, P/B = 28.4, P/CF = 43.0, D/C = 72.3%, PM = 6.1%
Recent Share Price: $43
VMware (NYSE: VMW) – Cloud software developer.
P/S = 5.5, PEG = 3.0, P/B = 8.4, P/CF = 27.4, D/C = 51.2%, PM = 11.9%
Recent Share Price: $154
Etsy (NSDQ: ETSY) – Online market for home goods and crafts.
P/S =13.7, PEG = 4.3, P/B = 29.5, P/CF = 95.6, D/C = 67.7%, PM = 8.3%
Recent Share Price: $100
Alteryx (NYSE: AYX) – Data analytics software developer.
P/S = 23.9, PEG = 45.5, P/B = 25.3, P/CF = 711.4, D/C = 62.4%, PM = 1.3%
Recent Price: $160
DexCom (NSDQ: DXCM) – Medical device manufacturer.
P/S = 23.9, PEG = 4.9, P/B = 40.2, P/CF = 192.1, D/C = 53.8%, PM = 9.2%
Recent Share Price: $400
Now that we know their identity, the more important question is how can we profit from this information? The simplest way is to buy put options on each of them, since put options increase in value when the price of the underlying security goes down.
The Other Side of the Mountain
For example, last week while YETI was trading near $43, a put option expiring on August 21 at the $42.5 strike price could be bought for $4.50. For this trade to be profitable, YETI would have to fall below $38 within the next eight weeks.
If YETI drops to $35 by expiration, the gain on this trade would be 67% ($42.50 – 35.00 = 7.50 intrinsic value divided into $4.50 premium cost). A 20% drop in YETI’s share price may sound extreme, but it was trading below $35 less than a month ago.
To maximize the probability of success, I suggest buying put options on at least three of these five companies. One of them might buck the trend, but it’s unlikely all of them would not succumb to a stock market correction.
Even if a stock market correction does not occur, it is unlikely these five companies can keep up their recent momentum. At some point, there should be some reversion to the mean.
Until COVID-19 has been eradicated, the stock market will remain quite volatile. Index investors may end up having nothing to show for 2020, and most likely next year, too.
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