The S&P 500’s total return year to date through April 16 is -13.9%. You would think that the index’s drop in value means S&P 500 stocks aren’t nearly as expensive as they were earlier in the year before the coronavirus took hold. But that isn’t necessarily the case.
According to INTL FCStone, a provider of financial services to middle-market clients, the S&P 500 could still be overpriced by as much as 35%. MarketWatch contributor Mark Hulbert recently discussed this notion with Vincent Deluard, INTL FCStone’s head of global macro strategy.
Using several assumptions, including a discount rate of 10%, Deluard found that the fair value of the S&P 500 is 1,800, well below its current level of 2,788.62. Interestingly, the discount rate at the index’s Feb. 19 high of 3,386, was 6.2%. In the two months since, the discount rate has risen to 10%, almost identical to its long-term average of 9.8%.
If the S&P 500 is overvalued by as much as 35%, many of its component stocks must be as well:
- Advanced Micro Devices (NASDAQ:AMD)
- Citrix (NASDAQ:CTXS)
- Digital Realty Trust (NYSE:DLR)
- Equinix (NASDAQ:EQIX)
- Jack Henry & Associates (NASDAQ:JKHY)
- Eli Lilly (NYSE:LLY)
- MSCI (NYSE:MSCI)
- Netflix (NASDAQ:NFLX)
- Regeneron (NASDAQ:REGN)
- SBA Communications (NASDAQ:SBAC)
Using cash flow and free cash flow valuation metrics (price-to-sales and price-to-free-cash flow), I’ve selected 10 S&P 500 stocks that I believe are overvalued and should be sold.
S&P 500 Stocks to Sell: Advanced Micro Devices (AMD)
Year to Date Total Return (through April 16): 24.2%
Price/Sale (P/S): 9.5
Price/Cash Flow (P/CF): 129.4
There is no question that most of InvestorPlace’s contributors are bullish about Advanced Micro Devices’ future. I’m not quite as upbeat, and the reason has everything to do with its valuation.
In my last article about AMD, I said that I didn’t think its stock was worth purchasing at current prices; it was trading around $58. It subsequently corrected like most stocks during the coronavirus-led meltdown, falling below $40 in late March. It has since rebounded back into the mid-to-high $50s.
In February, I also recommended that if you owned AMD, you shouldn’t sell it. Now that it’s come back up, I’m suggesting investors consider taking some profits.
If valuation weren’t a concern, I would agree with my colleagues that AMD is a “buy” at these prices. However, you could buy Nvidia (NASDAQ:NVDA) at 38 times cash flow, and that company boasts much higher free cash flow generation to boot.
If and when AMD stock drops back into the $40s, it’ll present a much better opportunity for investors.
Year to Date Total Return (through April 16): 36.1%
Citrix is currently trading at or near an all-time high. InvestorPlace’s Luke Lango recently recommended the company because its application virtualization software solutions allow employees to work from home more efficiently. Furthermore, the trend likely won’t go away once workers head back to the office in a few months.
In June 2019, I recommended investors consider Citrix’s stock because it was trading within 3% of its 52-week low. Since then, it’s up 57%.
“Citrix’s Intelligent Workspace is a platform for company applications that operate intelligently to improve productivity,” I wrote last June. “The company’s goal is to provide enough productivity improvements through its platform to give users back one day of their work week lost to moving between applications.”
In the first quarter of 2019, Citrix’s subscription revenue grew 37% and accounted for almost 20% of its overall sales. For the entire fiscal 2019, Citrix’s subscription revenue grew by 43% and accounted for 22% of its total sales.
While Citrix’s transition to a subscription-based business model is smart, I just don’t think it’s accomplished enough to justify 25 times cash flow. At $150, you might want to take some profits off the table.
Digital Realty Trust (DLR)
Year to Date Total Return (through April 16): 19.5%
The data center real estate investment trust gained 15.7% in March compared to a 12.4% decline for the S&P 500. It’s not hard to see why the REIT had such a strong month. Everyone and their dog are working from home. The coronavirus has proven why the cloud is so vital to our economy.
With internet use surging, the fact that DLR owns 267 data centers in 20 countries and six different continents, is a big selling point for buying its stock.
However, as Warren Buffett likes to say, “Price is what you pay, value is what you get.”
Baird analyst David Rodgers recently downgraded DLR stock to neutral on valuation concerns. Rodgers “sees little or no upside” for DLR stock, suggesting that in the next two years, it is going to see a lot of tenants rolling over compared to other areas of commercial real estate.
Furthermore, while DLR is defensive in nature, it has significantly outperformed its REIT peers. Eventually, reversion to the mean is going to slow it down.
“Stocks in our coverage are already trading at robust valuations at or in excess of our fair value estimates that already included substantial credit for portfolio lease-up and new development,” Rodgers wrote April 13.
Based on the analysts’ comments, Digital Realty Trust has exceeded expectations. Time to sell.
Year to Date Total Return (through April 16): 17.4%
A recent blog post from A Wealth of Common Sense highlighted the fact that 10 big tech stocks account for 23% of the entire U.S. stock market. This means that even massive companies such as Equinix account for the rest. The provider of retail, colocated data centers, has a $58 billion market cap and yet it’s on the outside looking in despite leasing space to some of the big tech stocks, including Microsoft (NASDAQ:MSFT) and Facebook (NASDAQ:FB).
Equinix stock has a year to date total return of 17.4% through April 16, 31 percentage points higher relative to the Morningstar U.S. Market Index. It’s one of the few bright spots in tech in 2020.
There is no question that Equinix’s leading position in the data center industry provides it with a rich valuation; it trades at 26 times adjusted funds from operations (AFFO), 30% higher than the industry average. Part of its attraction at this point has to do with the fact it tends to outperform in periods of market turbulence.
However, if DLR is expensive at 19 times cash flow, EQIX is overbought at 26x cash flow.
Jack Henry & Associates (JKHY)
Year to Date Total Return (through April 16): 13.9%
A total of 13 analysts cover Jack Henry, a provider of data processing solutions to more than 1,000 banks and financial institutions. Of the analysts covering the company, only two have an “overweight” or “buy” rating on JKHY stock. More importantly, the average target price is $160.50, 3% lower than where it’s currently trading.
On April 3, Jack Henry announced that it had rolled out its Paycheck Protection Program (PPP) solution that enables lenders to offer digital applications that can be filled out online by loan applicants and given conditional approval for PPP loans.
Digital solutions from companies like Jack Henry are great to have, but if the Small Business Administration has run out of the $349 billion in allotted funds, it doesn’t matter how good they are.
Further, companies such as PayPal (NASDAQ:PYPL) could have helped get the funds to small businesses more expediently. Unfortunately, the federal government didn’t approve their participation until April 10, a week after the PPP began accepting applications.
Speaking of PayPal, it is trading at 7.2 times sales and 28.2 times cash flow, which is cheaper than Jack Henry.
If you can own PayPal for the same valuation as Jack Henry, why wouldn’t you swap out one for the other? That’s what I would do.
Eli Lilly (LLY)
Year to Date Total Return (through April 16): 18.3%
Morgan Stanley analyst David Risinger downgraded Eli Lilly April 9 from overweight to equal-weight on valuation concerns. The analyst kept his target price at $148, which translates to a 4.3% downside over the next 12 months.
On March 23, Eli Lilly provided an update on its clinical trials during Covid-19.
While the company admitted that the novel coronavirus pandemic had affected its ability to continue its clinical trials, it did not see the need to change its guidance for 2020, despite many other pharmaceutical companies saying there exist many Covid-19 uncertainties.
Risinger suggested Lilly has performed well because it generates significant revenue from outpatient drugs that faceless Covid-related disruptions than those drugs dispensed in a hospital or through a doctor.
Eli Lilly historically has had a price-to-earnings ratio that’s higher than its peers. However, its current P/E premium is higher than at almost any time in its history. As for its price-to-sales and price-to-cash-flow, they are also much higher than their five-year averages.
With higher than usual unemployment possible in the next 12-18 months, the company faces a risk of lower U.S. commercial drug coverage.
It significantly outperformed its peers over the past five years. Thus, its stock may be about to revert to the mean and turn lower.
Year to Date Total Return (through April 16): 20.1%
Most of the companies that made this list did so because of valuation concerns, not because they aren’t excellent businesses. MSCI is a classic example.
In November 2019, I recommended MSCI stock as part of a 10-stock portfolio, where the first letter of each stock’s corporate name spelled out the word “RETIREMENT.” MSCI was the letter M. At the time; it was trading around $249. Since then, MSCI’s value has increased by 29% despite 2020’s major correction in the entire U.S. market.
What struck me at the time of my recommendation was how strong its performance had been over the previous five years. It had an annualized total return of 39% compared to 9% for the iShares MSCI USA Equal Weighted ETF (NYSEARCA:EUSA).
Five months later, MSCI has a five-year annualized total return of 39% compared to 4% for EUSA. While MSCI has managed to go sideways over these five months, EUSA’s five-year return has dropped by 500 basis points.
So, why the “sell” recommendation?
Well, it’s not so much a “sell” recommendation for those who already own the stock, but rather a “don’t buy now” suggestion for those considering buying in.
That’s because MSCIs price-to-sales and price-to-cash-flow ratios are 1.7x and 1.4x their 5-year average. Further, its PEG ratio is 3.65, 1.7x its five-year average.
MSCI is priced for perfection. A lengthy recession will likely take care of that.
Year to Date Total Return (through April 16): 35.7%
As if Netflix doesn’t already have enough competitors, come July 15, it’ll have one more: NBC is rolling out its Peacock streaming service across the U.S. this summer.
The added competition is one of several reasons why Benchmark analyst Matthew Harrigan recently initiated coverage of the world’s leading streaming service with a “sell” rating. He also has a $327 target price, 23% lower than where NFLX currently trades.
“Despite high customer additions and lower churn, we are concerned with mounting streaming competition, potentially restricted pricing power from a global economic downturn and surveys suggesting that streaming services are among the first household budget items to be cut with job losses,” Harrigan wrote in a note to clients.
In addition to all the issues mentioned above, Harrigan’s concerned that if the Covid-19 crisis carries on into 2021, Netflix won’t have enough content to keep pace with competitors who have more in-depth libraries.
The last time I wrote about Netflix in January, I was very bullish about its ability to compete with the NBCs of the world. What I didn’t factor into my “buy” recommendation was the coronavirus outbreak. At the time, I thought NFLX stock was cheaper from a valuation perspective than it had ever been, save for Aug. 2019 when it was trading around $250.
Today, my “sell” recommendation is based on the fact Netflix faces more headwinds than investors realize, and perhaps the run it’s been on is about to hit a wall.
Ultimately, I believe the company will get over that wall, but for now, I see little upside for NFLX stock.
Year to Date Total Return (through April 16): 43.8%
Regeneron is trading at levels not seen since Nov. 2015. Anyone who bought back then and is still holding is sitting on zero gains. That’s 54 months with nothing to show for it. It is these people that have got to be thrilled about the gains it’s made in 2020 as a result of its work to develop a coronavirus treatment.
On April 17, Benchmark analyst Aydin Huseynov upgraded Regeneron stock to a “buy” from “hold” on news the biotech company could make a cocktail of antibodies to protect health care workers until a proper vaccine is available. This move would generate as much as $50 billion in revenue for Regeneron in 2021.
Also, the Food and Drug Administration fast-tracked Regeneron’s approval process April 16 for its cocktail of antibodies, which were initially intended for the Ebola virus.
That said, clinical trials don’t start until June. Furthermore, although the analyst has upped his rating of REGN stock to “buy,” he admits that the cocktail’s chances of success are 50/50.
So, Regeneron is up 44% in 2020, with half those gains in the past month alone. Those are significant gains in a down market. Unless you can afford to lose all of your gains to date, I would consider taking profits.
If you’re one of those people who’s owned REGN since 2015, you better hope the company’s cocktail wins the day. If not, you’ll be back underwater in no time.
SBA Communications (SBAC)
Year to Date Total Return (through April 16): 28.3%
InvestorPlace contributor Matt McCall recommended in November 2018 that SBA Communications, an owner of more than 30,000 cell towers in North America and South America, was an excellent stock to play the 5G revolution. It’s up 88% in the 18 months since.
The great thing about SBAs business is that no matter what happens in the 5G revolution, cell towers are still a necessary part of the technology. Until someone figures out how to eliminate cell towers, SBAC is a real estate investment trust that is going to attract a lot of attention.
That’s why it’s up 28% in 2020, while the markets as a whole have a total return of -14%.
Interestingly, of the 15 analysts covering SBAC stock, 11 have it as a “buy” and another gives it an “overweight” rating. Yet, its average 12-month target price is $309.93, suggesting there is little potential for upside over the next year.
As I like to say, you’ve always got options.
American Tower (NYSE:AMT), which owns 180,000 cell towers around the world, has price-to-sales and price-to-cash-flow ratios of 14.8x and 29.9x, respectively. Those are both lower than SBAC.
So, like MSCI, it’s not so much that I think SBAC is a “sell,” but rather that it is priced for perfection, and thus likely to see a bit of a correction over the next 6-12 months.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.