The past few years I have sat down in the first half of January and put together a list of stocks I felt like investors should avoid for the next year. I kept it pretty simple and just screened for stocks that trade at very high multiples yet have low F-scores. This gives me a bunch of companies that are very popular with investors and traders but do not necessarily have the fundamentals that justify the price. I then added a simple filter and reduced the list to those that have under-performed the S&P 500 over the past month and may be starting to fall out of favor. When a glamour stock loses the support of the momentum crowd, things can get real ugly real fast.
The results have been pretty good. By good I mean most of the stocks did indeed continue to under-perform the market for a period. Some of them got decimated as momentum investors dumped their shares and moved onto the next exciting stock. The track record is not perfect as a few kept going higher, but for the last three years investors would have done well by avoiding or selling stocks that are highly valued and beginning to fall out of favor.
Top of the list again this year is Under Armour (UA) . This stock was an overvalued pick last year as well, and it's had a weak 2016. Under Armour has made just about every list of potentially overvalued stocks I have run for the past year, and the stock has not done much for the past few years. Although it made a good run, the stock is now down close to 2014 levels so long-term shareholders have had a roller-coaster ride but are now just treading water. The stock is trading at 66x earnings and has an F-score of just 3. Fundamentals would have to show rapid improvement even to begin to justify the current valuation, and I would avoid the stock for now. There are signs that traders are falling out of love as the stock is down 15% in the past month.
World Wrestling Entertainment (WWE) is another stock that appears to be slipping fundamentally and losing the support of their investor base. Once they announced a convertible bond deal in mid-December the stock sold off sharply as investors are concerned about dilution. While the WWE Network is a very good idea and should provide strong cash flows, I am not sure how much it will grow. A certain percentage of the population likes wrestling enough to use the service, but I am not certain how you grow that percentage. The stock is trading at 57x earnings, and the F-score is just 4 so I do not see a compelling reason to own the stock. There has been some takeout chatter around the stock, but keep in mind that the UFC buyout was done at a 22 EBITDA multiple and WWE is already trading at a multiple of 20 so there's not a lot of upside even if they get the same premium pricing.
Analysts have high expectations for Healthcare Services Group (HCSG) over the next year and it is reflected in the share price. The shares trade for 42x trailing earnings and 32x hoped-for earnings, so it's hard to make a case for the stock based on valuation. The company has an attractive business as they supply laundry, maintenance and dietary services to nursing homes, retirement communities, rehabilitation centers and hospitals in the U.S. I have to say that I like the business and if I could buy it at a single-digit EV/EBIT ratio instead of the current 27 multiples this might well be a backup-the-truck stock. Unfortunately, Wall Street likes the business as much as I do and the shares are far from a bargain. The F-score is just 4 right now, so the fundamental outlook is not as strong as the analyst's community is expecting. Should they miss estimates a time or two perhaps the stock would come down into the zone where we could buy it a bargain price, but for now I would avoid this stock.
Avoiding stocks with high multiples and low F-scores that are lagging the market has worked out very well the past few years. I suspect it will be again this year.
