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  1. Home
  2. / Investing
  3. / Energy

Avoid the Wildly Overvalued Big-Caps

Still, there are some bargains to be had in blue-chip oil and gas.
By TIM MELVIN Oct 22, 2013 | 03:00 PM EDT

The stock market continues to climb the wall of desperation as investors rush to catch up with the rally. The new mantra is now "quantitative easing forever," and this has been widely and wildly trumpeted this morning by the financial media. The jobs report was weak at best, and it caused U.S. Treasury bond yields to pull back once again.

But, in the current environment, bad is good and good is great -- and we are still seeing money forced into the stock market. There is simply nowhere else to go, according to most pundits and gurus. They are probably right as long as we see a zero-interest-rate policy (ZIRP) remain the rule of the land, but there is no reason to be silly about it, in my opinion.

No matter how much you need a return on your dollar or a source of dividend income, investors need to keep in mind that they are buying into a corporation or enterprise that has a definable value. I use a model that takes into account current earnings cash flow and assets, as well as current mergers-and-acquisitions pricing levels, as I calculate the intrinsic value of individual stocks. It is not precise to the penny, as that is probably impossible -- but, over the years, it has proven its accuracy to within a few percentage points.

On Monday I looked at how the big pharmaceutical stocks measured up, and found that they were overvalued by a fairly large factor. Today I want to look at some of the other major companies that are widely held by both the big funds and by individual investors. (I use a completely different set of metric for non-financial companies, so I will stick with valuing non-financial companies and see if we can find any big-cap bargains.)

Microsoft (MSFT) is one of the most widely held stocks by every type of investors. The company is a cash machine that generates free cash flow in the tens of billions annually. It pays a decent dividend and can probably grow at a nice pace for an extended period. However, no matter how far I stretch the inputs to the positive side, I cannot get to a share valuation above $23.50 -- and the stock is currently at around $35. I do not see a scenario in which this company would be able to grow at more than a high-single-digit pace for a long time, and the stock is not worth the current price.

Meanwhile, it seems everybody owns Apple (AAPL). This is a great company that has not just customers but fans: People will camp out to buy a new version of an Apple product that is not that much different from the old one. Apple also generates enormous amounts of cash flow, and it has $442 billion in the bank. But, using my numbers, I cannot come up with a valuation of anything above $370 per share for Apple, which is currently priced at around $525. It is a great company, but I am not so sure it will be a great stock over the next few years.

Individuals have also long been in favor of owning the phone companies for their dividends and steady growth potential. I am a big fan of them at the right price, but my calculations show that they are well above a fair price right now. I come up with a valuation of $26 for AT&T (T) -- currently at $35 -- and $28.75 for Verizon (VZ), which has a current price of $50.57. As with so many of these large companies, they have premium multiples of earnings and assets in spite of limited growth opportunities in a weak economy and competitive marketplace.

The one blue-chip sector that appears to have some value right now is that of the major oil companies. Exxon Mobil (XOM), at $87.55, trades at a slight premium to its intrinsic value of $82. Meanwhile, Chevron (CVX) is one of the few big blue chips trading at a discount to its current price. My model shows a fair value for the company at $135.50, well above its current price of around $120. The most underpriced major oil right now is BP (BP), which trades at around $44 -- a wide gap from its $69 fair-value calculation.

Most blue-chips, then, are not cheap right now, and they tend to trade well above the value of the business. Still, I am not suggesting you run out and short these stocks. I am not even saying you should dump them if you own them right now. Evidence suggests that, if you had bought these right during a broad-market decline, the best course of action is to hold them and just ride the bumps of the market.

But the data also suggest that, for investors with new money to put to work, it would be best to avoid the large-cap stocks that have soared in price the past few years and are trading well above their intrinsic value. Again, there does appear to be some value in the major oils and growth. For the time being, therefore, income investors might be best to confine their search to that sector of the market.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

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

TAGS: Investing | U.S. Equity | Energy | Technology

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