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3 Stocks That Are Overvalued

By John Rosevear, Keith Speights, and Reuben Brewer – Apr 10, 2017 at 10:20AM

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These are all good businesses, but their stock prices may have raced past their fundamentals.

Sometimes, a stock that looks expensive really isn't. Often, on closer examination, you'll find that despite so-so financials now, the company has a path to big growth that has attracted sharp investors.

But sometimes, investor enthusiasm gets out of hand, and a company's value runs a bit too far ahead of its fundamentals. That can be true even of good companies that we'd be happy to own at more sensible prices. Here's why our Foolish specialists think Stanley Black & Decker (SWK 2.06%)Glaukos Corporation (GKOS -0.29%), and Ferrari N.V. (RACE 2.40%) are looking expensive at current prices. 

A Ferrari Formula One race car at speed on a racing track.

Ferrari's Sebastian Vettel in practice before the Australian Grand Prix in Melbourne last month. Vettel won the race, the first of the 2017 Formula One season. Image source: Ferrari N.V.

Even Ferrari can be too expensive

John Rosevear (Ferrari N.V.): It's Ferrari! Of course it's expensive! It's the only company that can claim to be one of the world's most coveted luxury brands and one of the world's most widely followed sports teams. Is it even possible for Ferrari -- Ferrari! -- to be overvalued?

Alas, there's "expensive" -- and then there's "32 times last year's very good earnings." That's genuinely expensive, even for Ferrari. 

If you've followed the stock, you'll recall that Ferrari's stock stumbled off the line after its initial public offering and separation from longtime owner/patron Fiat Chrysler Automobiles (FCAU) back in 2015. But in recent months, after a strong finish to 2016, it's been hitting on all 12 glorious-sounding cylinders:

RACE Chart

RACE data by YCharts.

Now, there's some justification for the recent run-up. As mentioned, Ferrari had a good 2016: Its net income jumped 38% to 290 million euros on a 9% year-over-year revenue gain. Upbeat guidance, a couple of analyst upgrades -- and a season-opening win for Ferrari's Formula One racing team in Australia -- gave the stock some additional gas in March.

So much gas, in fact, that the stock price now looks to be a bit ahead of Ferrari's fundamentals. 

Ferrari CEO Sergio Marchionne has argued that as a luxury brand, it should trade at a higher multiple than the roughly 10 times earnings we'd expect of an ordinary automaker in good times. That's a fair point. But Ferrari's recent run-up has taken it past well-established luxury names like Tiffany and Company and LVMH Moët Hennessy, both of which trade around 26 times earnings. 

Remember, when you look past the fabulous brand, Ferrari is a high-fixed-cost cyclical industrial company. It had a fairly pedestrian 9.8% adjusted EBITDA margin last year, along with a debt load that (as of the end of 2016) exceeded its cash on hand by 653 million euros. It's also a company that may have limited potential for profit growth, as Ferrari limits its annual sales to preserve exclusivity. 

Ferrari is a solidly profitable company with a brand and history that provide a unique moat: No other company can be Ferrari. But right now, I'd wait for Ferrari's stock to throttle back before jumping in. 

Great company, not so great price

Reuben Gregg Brewer (Stanley Black & Decker): Stanley Black & Decker owns a collection of iconic brands. It's been expanding that portfolio through acquisitions over the past few years, most recently through agreements to buy Sears Holdings' (SHLDQ) Craftsman brand and the tools business of Newell Brands (NWL 0.13%). It's also worth noting that Stanley has increased its dividend for 49 consecutive years.  

In fact, there's a lot to like about Stanley Black & Decker's future. The only problem is price. Based on some metrics, the company appears, perhaps, fairly valued, including a price to earnings ratio of around 20 and a price to cash flow ratio of around 13. Neither is particularly out of line with the company's historical range. However, price to book is the highest it's been in the last 10 years, and the dividend yield, at 1.75% (or so), is the lowest it's been since the turn of the century.

SWK Dividend Yield (TTM) Chart

SWK Dividend Yield (TTM) data by YCharts.

If you are looking for good deals, Stanley doesn't fit the bill. In the best-case scenario, investors have priced in the many positives. But the historically low yield and high price-to-book ratio suggest to me that investors have priced in perfection. Now isn't the time to buy this iconic name, though you might want to keep it on your watchlist.   

Eyeing a great future, but...

Keith Speights (Glaukos Corporation): There is no question that Glaukos has a tremendous technology with its iStent micro-bypass stent system for treating glaucoma. I don't doubt for a second that iStent will quickly become a standard of care. What I do doubt, though, is if this stock is worth its current valuation, even with all of the great potential.

Glaukos shares trade 102 times expected earnings. While that might appear downright cheap when compared to the stock's trailing-12-month earnings multiple of 435, it's not cheap by any stretch of the imagination.

It's definitely true that Glaukos has enjoyed huge sales growth in recent years. Since the iStent was introduced in 2012, the company has seen steadily increased revenue. Over the last 14 consecutive quarters, Glaukos has racked up year-over-year net sales growth of at least 40%. That kind of performance tends to drive share prices higher.

Even if Glaukos managed to achieve earnings growth at the same level of its sales growth (so far, it hasn't), two questions come to mind. First, could Glaukos sustain a 40% annual sales and earnings growth rate? Wall Street doesn't think it can. Analysts project an impressive (but still lower) annual earnings growth rate of 25% over the next five years. Considering that it's fairly common for groundbreaking technology to see growth taper off somewhat after the first few years of launch, I suspect Wall Street's projections are probably close. 

The second question is this: Is Glaukos overpriced even if it could achieve 40% annual earnings growth? I'd say it is. A 40% earnings growth rate would give Glaukos a price/earnings-to-growth (PEG) ratio of more than 2.5. That's too steep, in my view. This is a great company with a great product, but the stock is priced in the stratosphere.

John Rosevear has no position in any stocks mentioned. Keith Speights has no position in any stocks mentioned. Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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