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  1. Home
  2. / Investing

Egregiously Overvalued Stocks to Avoid

The first installment of my list includes biotech, Internet and insurance.
By TIM MELVIN Jan 02, 2015 | 02:00 PM EST
Stocks quotes in this article: YELP, LYV, MDSO, EHTH, FB, AMZN, TWTR, LNKD, SFM, NDLS, LAMR, VMC

At last we have turned the page on the calendar and 2015 is here, all bright, shiny and new. The daughter is back up North, so I can indulge in my daily sending of weather forecasts, my son is back at his apartment downtown instead of crashing on the upstairs couch and an eerie quiet has descended upon Chez Melvin.

The forecasting circus is starting to wind down and it is back to business as usual. In spite of the New Year's celebrating and hangover recovering this week, not much really changed in the world when the clock ticked over on Wednesday night. The world looks remarkably like it did in 2014.

As I have often said, any attempt to predict the rest of the year is just a fool's errand. Investors should focus on valuation and valuation alone in their search for returns. As a reminder, valuation is as important in identifying stocks to sell or avoid as it is picking undervalued stocks with the potential for outsized returns to buy. As the end of 2013 approached, I wrote a column that outlined some stocks with triple-digits earnings yield that investors should avoid in 2014.

With the exception of Facebook (FB), all of the stocks identified underperformed the market in 2014.

Investors who bet on the big-name exciting stocks like Amazon (AMZN), Twitter (TWTR) and LinkedIn (LNKD) lost money in 2014. So did those who bet on triple-digit multiple stocks like Sprouts (SFM) and Noodles (NDLS), while expensively-valued stocks like Lamar Advertising (LAMR) and Vulcan Materials VMC) were in the black, but lagged the market. An equally-weighted portfolio of the entire triple-digit multiple stocks was a net loser on the year.

I think I will make this an annual tradition. Stocks trading at triple-digit multiples of earnings are just betting slips. You are not investing, so much as playing a rousing game of pass the burning match that the individual investor is pretty much doomed to lose. Those not trading tick by tick would be wise to avoid the popularity contest that is trading the triple-digit multiple stocks and focus on finding bargain stocks with a margin of safety.

Yelp (YELP) is at the top of our list of egregiously overvalued stocks. My wife loves Yelp and uses it constantly, as I do and a lot of other folks. It is a handy little service when traveling, but that does not make it worth 2280x earnings. While analysts are expecting great things for the company, Yelp still trades for more than 130x the optimistic expectations. It is a neat company, but a potentially dangerous stock at this price.

LiveNation (LYV) has a pretty good business. It manages live entertainment venues, promoting events and selling tickets to events. Earnings are growing nicely and the analysts are very positive about growth. As nice as that is, I don't see anything that justifies a stock price that is 2600x current earnings and 87x times the sunshine and glitter covered expectations for 2015.

Mediadata Solutions (MDSO) has all the buzz words and hot sectors in its favor. It provides cloud-based clinical development systems for pharmaceutical, biotechnology, medical device and diagnostics companies. I am sure it is a solid company in a great spot in the current economy, but at 2380x this year's earnings and more than 50x analyst expectations for 2015 there is no margin of safety or margin for error in this stock at the current price.

EHealth (ELTH) is also in a current economic hot spot. It offers online health insurance services for individuals, families and small businesses in the United States. It has benefited enormously from the Affordable Care Act, as millions of consumers have flocked to websites like theirs to find coverage under the new laws. As exciting as that may be, it's an insurance brokerage and I am not aware of any insurance agency anywhere that has traded hands at 489x current earnings and more than 150x expected profits in the next year.

Buying stocks with triple-digit earnings multiples is not investing. It is gambling. You would be better off as an investor putting your entire portfolio in community bank stocks and going to the racetrack every weekend to satisfy your urge to speculate.

We have a lot longer list of triple-digit betting slips this year, so I will look at some of more of these best-avoided stocks on Monday

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At the time of publication, Melvin had no positions in any of the securities mentioned.

TAGS: Investing | U.S. Equity | Stocks

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