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  1. Home
  2. / Investing
  3. / U.S. Equity

Stay Away From These Large-Cap Value Sinks

All large-caps are overvalued, but these stocks are the worst offenders.
By TIM MELVIN Aug 10, 2016 | 02:00 PM EDT
Stocks quotes in this article: CRM, AMZN, S, FE, NFLX

I had a chance yesterday to catch up with a friend and talk about the markets. During the course of the conversation, he asked if I saw any large-cap stocks that I liked in the current market. I stated flatly that in my opinion, U.S. large-cap stocks were the most overvalued I had ever seen them, and I would not touch them, right now. Although I do feel that way, it is based on anecdotal evidence. So I sat down last night and began to quantify that a little bit.

I found 410 U.S. companies that have a market cap of more than $10 billion. I crunched some numbers and found that the average large-cap stocks currently trade with an average Enterprise Value to Ebitda ratio. The median EV/Ebitda ratio in this group is 13.31 -- which is more than twice the 6x multiple that Apollo's Leon Black talked about last week as being a bargain level. It is 30% higher than the median deal multiple paid by private equity shops this year. In both 1999 and 2006, the average S&P 500 Ebitda multiple topped out at about 12. In contrast, the average EV/Ebit ratio for the group I looked at, with market cap above $10 billion, is an eye-popping 25.

Traditional valuation metrics don't look any better. The average price-to-book-value ratio of the 410 stocks was 12. When I backed out those with negative equity, the price-to-book ratio is 20. The average P/E ratio was 36 -- 38 if you backed out the handful of unprofitable companies. The median P/E ratio was 23. The average dividend yield was just 1.94%.

While I know all about stocks being the only game in town, right now, please don't try to tell me the market is cheap. It is not, by any reasonable measurement.

With that in mind, I decided to sit down and look at those companies with the highest EV/Ebit multiples -- with an eye to finding those that should be sold or avoided right now. The very highest multiples belong to companies like Salesforce (CRM)  ,Netflix (NFLX)  and Growth Seeker holding Amazon (AMZN) . And I already know the growth groupies will tell me that these are the super growers, and deserve high multiples. I don't really agree, but let's limit our universe to those stocks that the cheerleaders -- also known as Wall Street analysts - think will grow by 5% or less over the next three to five years. This gives us a list of highly valued companies that will not be able to grow into more reasonable valuations.

The most overpriced low-growth stock right now is Sprint (S) . The wireless business is ridiculously competitive -- and we are seeing a change in pricing as low, fixed-rate unlimited plans are grabbing market share from more-established companies, like Sprint. It does not help that Sprint has a reputation for unreliable service: Everyone one I know that uses the company complains about excessive dropped calls and poor reception. The company is highly leveraged, and it is not likely that we will see a bottom-line profit until at least 2019. The stock has had a great run on great expectations, and is up over 70% this year. After this move, the stock trades with an EV/Ebit ratio of 70 -- and that is just too high, given the current business conditions and prospects.

I have said for some time that electric utilities are very overvalued, and FirstEnergy (FE) helps prove the point by making its way onto the list of no-growth, highly valued companies. FirstEnergy serves about six million customers in Ohio, Pennsylvania, West Virginia, Maryland, New Jersey, and New York. I will go ahead and speculate that buyers have been attracted to the stock because of its generous 4.4% dividend in a yield-starved world, but you are paying a very high price for the operating business. Analysts are currently projecting that earnings will contract a little over the next three to five years, and I have a very hard time seeing how a shrinking business that even in the best of times can't grow much faster than the economy is worth an EV/Ebit multiple of 61.

It turns out that my observation is correct. Blue chips are as overvalued as I have ever seen them. I can't justify buying any of them, but those with slow-to-no growth should definitely be avoided by investors with new money to invest, and folks who own these stocks might want to consider selling them outright.

Tomorrow, I will take a look at the other slow-growing, richly priced stocks that I uncovered.

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

TAGS: Investing | U.S. Equity

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