After my recent looks at cheap stocks in the cheapest groups it just made sense to examine the most expensive sectors, as measured by Shiller P/E, and look for stocks in these groups that trade at high multiples and have landmines lurking on the balance sheet and in fundamental company conditions. Stocks with high valuations and low Piatroski F- and Altman Z-scores would seem vulnerable to large declines. And with everything going on in the world right now the last thing I want to be is vulnerable if we get a steep decline.
Biotechnology is the most expensive group based on Shiller P/E but I generally refrain from commenting on it. I think you need specialized knowledge well above my pay grade to invest in this group. I am well aware of the potential of biotechs as they are developing cures for diseases and conditions once thought incurable. However, I believe you need someone who understands the science and medicine involved and that traditional valuation and measurement tools are worthless.
The second highest valued industry is drug manufacturers. Although a lot of the valuations are extremely high, the one that stands out is AstraZeneca (AZN). The stock is trading at an enterprise value/EBIT multiple of 55x and a price-to-book value ratio of 4.88. The Z-score is 1.99 and the F-score is 3 so this is not a company with a strong balance sheet and prospects are worsening right now. No matter how good the story around the stock might be, by the numbers this is a fairly risky issue at the moment.
Restaurants is next on our list of overvalued sectors. I must confess I've always had a negative bias for this group as in my learned opinion the only decent casual chain restaurant in history is the Waffle House. Wendy's (WEN) and Popeyes Louisiana Kitchen (PLKI) are also fast food favorites of mine but, in general, I don't like most companies in the space. So, having disclosed my bias, I have to say that valuations in this sector make my eyes bleed. I may love that chicken from Popeyes but an EV/EBIT of 21x and a price-to-book of 18 is a real appetite killer.
The most vulnerable stock in the group looks to be Dave & Buster's (PLAY). Maybe it's because I'm older but this is one concept I never understood. It's basically beer, bar food and video games and none of it is priced cheaply, in my view. These restaurants are loud, unpleasant places, in my opinion, but I doubt I'm their target market. Everyone loved the recent earnings report, as the company beat estimates, but the numbers say the future might not be as bright as the analysts are hoping. PLAY earns an F-score of just 3 and the Altman Z-score is at the high end of the gray zone at 2.3.
Other stocks in the restaurant group with dangerously high EV/EBIT ratios and poor F-scores include Potbelly (PBPB), Buffalo Wild Wings (BWLD) and Yum! Brands (YUM).
I expected to see online media among the highly valued sectors. Once again there was cranial bleeding as I examined the lofty land of internet media valuations. The leading companies in this sector have wildly inflated EV/EBIT multiples and P/BV ratios are in the stratosphere. I have found Z-scores to be of little use with these companies as most have quite a bit of cash on hand and easily pass the test. Looking at F-scores, however, most of the industry leaders have scores that indicate conditions and prospects are improving and that might be enough to keep the momentum going. Facebook (FB), for example, has an EV/EBIT of 50x but the F-score is 7, which tells me that results could continue to be strong and the "mo-mo" crowd will keep pushing it higher. (Facebook is a holding in Jim Cramer's charitable trust portfolio, Action Alerts PLUS.)
Still, there are some stocks that are a bit of concern in this group. LinkedIn (LNKD) has an F-score of just 3 and trades with a high EV/EBIT so the stock is richly priced and vulnerable to declines based on its financial condition.
The lowest F-score in the group is Baidu's (BIDU) 2. Given its EV/EBIT of 21x there could be more downside ahead for the Chinese internet company. Bankrate (RATE) also looks vulnerable with an F-score of 4 and EV/EBIT multiple of 30x.
I can't predict markets, but I do know that risk levels appear to be rising and there are several macroeconomic and geopolitical events out there capable of derailing the markets. It is probably best to avoid highly valued stocks in hot sectors where conditions are worsening.