How Can You Tell a Stock is Overvalued?
This article originally appeared on Traders Reserve.
A lot of companies have posted stellar earnings during the past year, and many continue to gain market share. These stocks have justifiably seen a surge in share price, e.g., Apple (NASDAQ: AAPL). But others just seem to be along for the bullish ride and may have run up a little too far in front of their earnings potential.
One way to measure whether a stock is overvalued is to look at the price-to-earnings-to-growth ratio, or PEG ratio. A stock that is considered fairly valued will have a PEG ratio of 1, which simply means the price-to-earnings (P/E) ratio equals the estimated earnings growth. Traditionally, a PEG ratio over 1 means the stock is overbought.
The five stocks on this list can be considered overvalued based on their high PEG ratios, and also because each has seen a big surge in value during the past year and could be due for a pullback. If you own them, you should think about taking your profits off the table by selling these overvalued stocks now.
Stock to Sell #1 – OpenTable
This online restaurant booking software stock has been a darling of investors for the past year. OpenTable (NASDAQ: OPEN) shares spiked over 198% in the past 12 months, giving shareholders a new meaning to eating out all the way to the bank.
But recently, Stifel Nicolaus cut its rating on shares to “hold” from “buy,” citing the online software’s high valuation. With a PEG ratio of 3.13, now may be the time for investors to quit booking Open Table shares.
Stock to Sell #2 – Harley-Davidson
Iconic American motorcycle brand Harley-Davidson (NYSE: HOG) has twisted the throttle on its stock, climbing nearly 67% during the past six months. Over the past year, the company’s stock has rumbled more than 47% higher.
Harley-Davidson just posted earnings that actually beat the consensus forecast; however, it did so on a 24% decline in U.S. sales, and a 2% decline in international sales. With slowing sales, the company had to rely on cost-cutting to make its quarter, and this cost-cutting can’t last forever, and with a PEG ratio of 3.4, this is one overvalued hog whose ride has likely come to an end.
Stock to Sell #3 – Salesforce.com
Salesforce.com (NYSE: CRM) is a customer relations management software maker that helps businesses increase their efficiency. The company’s earnings have been solid over the past several years, and investors have been rewarded with an 85% gain in the past 12 months.
While we think Salesforce.com will continue earning money, at a PEG ratio of 4.14, it definitely falls into the overvalued column. If you have profits in this stock, now just might be the time to increase your portfolio’s efficiency by selling your CRM shares.
Stock to Sell #4 – Wynn Resorts
Wynn Resorts (NASDAQ: WYNN) has been betting on Wynn Macau in China as its ace in the hole to continue its earnings and stock price run. While gaming stocks (especially casino stocks) are up, Wynn is flying in the stratosphere. The stock price nearly doubled in 2010, pushing its P/E ratio to an astronomical 363 and it’s PEG ratio to 2.31. With Chinese economy beginning to tighten and the US on a slow recovery, Wynn may have trouble keeping up its torrent growth pace. That means that if you’re riding this overvalued rollercoaster, it could be a good time to get off and sell this overvalued stock now.
Stock to Sell #5 – Amazon.com
Online retailer Amazon.com (NASDAQ: AMZN) stock has posted a most impressive gain of over 22% just in the past three months, and over the last 12 months, the stock is up more than 44%. The stock has a PEG ratio of 2.78, so it can be said to be overvalued here. But the real headwinds for Amazon could come from Apple (NASDAQ: AAPL) and Sony (NYSE: SNE). Both companies have e-readers with greater functionality than Amazon’s Kindle, and if these devices start to take market share from the Kindle, it could be the catalyst investors need to turn the page on AMZN.
