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5 Speculative and Overvalued Companies to Avoid – November 2014

5The market is filled with companies with a lot of hype which are touted as great investments, but Benjamin Graham taught that intelligent investors must look past the hype and avoid speculating about a company’s future.  By using the ModernGraham Valuation Model, I’ve selected five of the most overvalued companies reviewed by ModernGraham. Each company has been determined to not be suitable for either the Defensive Investor or the Enterprising Investor according to the ModernGraham approach. This is a sample of one screen that is included in ModernGraham Stocks & Screens, which is available for premium subscribers and is a great resource for selecting better opportunities.  Defensive Investors are defined as investors who are not able or willing to do substantial research into individual investments, and therefore need to select only the companies that present the least amount of risk. Enterprising Investors, on the other hand, are able to do substantial research and can select companies that present a moderate (though still low) amount of risk. Each company suitable for the Defensive Investor is also suitable for Enterprising Investors.

Netflix Inc. (NFLX)

200px-Netflix_logo.svgIt is clear that conservative value investors may wish to seek other opportunities. The Defensive Investor is concerned with the low current ratio in combination with the lack of dividend payments and high PEmg and PB ratios, while the Enterprising Investor has concerns with the low current ratio and lack of dividend payments. As a result, both investor types would find the company to be too risky to proceed. That said, any investors willing to speculate about the future of the company may go ahead with the next step of the analysis, which is a determination of the company’s intrinsic value.

When calculating an estimate of intrinsic value, it is important to consider the historical earnings results along with the market’s implied estimate for future growth. Here, the company has grown its EPSmg (normalized earnings) from $1.96 in 2010 to only an estimated $2.42 for 2014. This level of demonstrated growth is in stark contrast to the market’s implied estimate of 74.66%. In fact, historical growth has only been 4.79% in recent years. There would have to be an incredible increase in the company’s growth in order to be worth the current market pricing, and such a growth rate would be unsustainable over a 7-10 year period. As a result, the company appears to be significantly overvalued at the present time.  (See the full valuation on Seeking Alpha)

Merck & Company (MRK)

logo_MerckMerck & Company does not qualify for either the Defensive Investor or the Enterprising Investor.  The Defensive Investor is concerned by the low current ratio, lack of earnings growth over the last ten years along with the high PEmg and PB ratios.  The Enterprising Investor is similarly concerned by the lack of earnings growth over the last five years along with the high level of debt relative to the net current assets.  As a result, value investors following the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities at this time.  From a valuation side of things,  the company appears to be overvalued after seeing its EPSmg (normalized earnings) drop from $2.66 in 2010 to only an estimated $2.23 for 2014.  This demonstrated lack of growth clearly does not support the market’s implied estimate of 9.01% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value well below the price.  (See the full valuation)

Gamestop Corp (GME)

200px-GameStop.svgGamestop Corp is not suitable for either the Defensive Investor or the Enterprising Investor.  The Defensive Investor has concerns with the low current ratio, lack of sufficient earnings stability or growth over the last ten years, and the high PEmg ratio.  Meanwhile, the Enterprising Investor has concerns with the low current ratio, and the lack of sufficient earnings stability or growth over the five year period.  As a result, value investors following the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities such as Apple Inc. (AAPL).  From a valuation side of things, the company appears to be significantly overvalued after seeings its EPSmg (normalized earnings) drop from $1.92 in 2010 to $1.41 for 2014.  This demonstrated drop in earnings leads the ModernGraham valuation model to return an estimate of intrinsic value well below the market price.  (See the full valuation)

ConAgra Foods Inc. (CAG)

200px-ConAgra_Foods_logo_2009.svgConAgra Foods does not qualify for either the Defensive Investor or the Enterprising Investor.  The Defensive Investor has concerns about the low current ratio, the insufficient earnings growth over the last ten years, and the high PEmg and PB ratios.  The Enterprising Investor is concerned by the level of debt relative to the net current assets and the lack of earnings growth over the last five years.  As a result, value investors following the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities.  From a valuation side of things, the company appears overvalued after seeing its EPSmg (normalized earnings) drop from $1.40 in 2010 to only $1.32 for 2014.  This demonstrated drop in earnings does not support the market’s implied estimate of 7.9% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value below the price.  (See the full valuation)

Northern Trust Company (NTRS)

Northern_Trust_LogoNorthern Trust is not suitable for either the Defensive Investor or the Enterprising Investor.  The Defensive Investor is concerned with the insufficient earnings growth over the last ten years and the high PEmg ratio.  The Enterprising Investor has an issue with the lack of earnings growth over the last five years.  As a result, value investors following the ModernGraham approach based on Benjamin Graham’s methods should explore other opportunities.  As for a valuation, the company appears overvalued after growing its EPSmg (normalized earnings) from $3.11 in 2010 to an estimated $3.00 for 2014.  This level of demonstrated growth does not support the market’s implied estimate of 7.30% earnings growth and leads the ModernGraham valuation model, which is based on Benjamin Graham’s formula, to return an estimate of intrinsic value below the market price.  (See the full valuation)

What do you think?  Are these companies a bad opportunity for Intelligent Investors?  Is there a company you like better?  Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.

Disclaimer:  The author did not hold a position in any company mentioned in this article at the time of publication and had no intention of changing those holdings within the next 72 hours.  Logos are taken from either the company page or Wikipedia for purposes of identifying the company only; ModernGraham has no affiliation with the companies.

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