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  1. Home
  2. / Investing
  3. / Financial Services

Stocks Are Priced for Perfection in an Imperfect World

Take a few minutes to check the level of institutional ownership in the stocks you own.
By TIM MELVIN Nov 14, 2016 | 11:00 AM EST
Stocks quotes in this article: PCLN, SPG, BXP, AMT, VNO, ESS, DLR, JEC, MLM, FLR

It seems that everyone's favorite question this week is "What do I do with my money now that Donald Trump is going to be the next president?" The financial media has been full of such discussions since last Tuesday. It was hard to find an article in this week's Barrons that didn't have Trump in the headlines. People I haven't talked to in an extended period suddenly felt the need to email me and ask what stocks I liked now that we have a new president and a GOP-controlled Congress. My answer is: The same ones I liked last week, and it's a very short list.

A look at the data in that same issue of Barrons shows me that the S&P 500 is still valued at right around 25x earnings. Earnings grew at about 3% year over year for the third quarter, and I find it difficult to justify that multiple on weak growth. While Mr. Trump's policies may ultimately be good for business and bottom-line profits, it will be a while before he manages to pass them and still longer to fully enact them. In the meantime, stocks are priced for perfection in an imperfect world, and I continue to think a healthy dose of caution is in order when approaching the stock market right now.

I had several conversations about stocks to avoid right now, given the state of the economy and valuation of the market. Rather than single out a particular sector or industry group, I think that the most dangerous stock are those high-PE stocks where institutions own most of the outstanding shares. If something does go wrong, it's going to be a very crowded exit window -- and there is no one left to buy them until they fall to bargain levels. That could be a very long drop indeed for many of these issues.

It is worth noting that I looked at the recent performance of the heavily owned, high-multiple stocks, and we won't be missing anything by dumping them. As a group, they have severely underperformed the market in recent years, even as the broad market was climbing towards new all-time highs. I also note that much of the ownership is by ETFs, and these shares will see indiscriminate forced selling in a broad decline in the markets.

Priceline (PCLN) is the poster child for over-owned overvalued stocks. About 96% of the company is owned by institutions, and the travel website operator's shares trade for almost 30x earnings. The stock has had an incredible run over the last decade, and any growth fund that doesn't own the shares would be chastised by its shareholders for such an egregious oversight. I suspect that anyone with interest in the stock already owns it, and an earnings report that falls short of the estimate or broad market decline could send the shares tumbling.

I see a lot of Real Estate Investment Trusts on the list of high-multiple stocks with more than 90% institutional ownership. I am a huge fan of real estate as an asset class, but yield-seeking has put a lot of upward pressure on many REITs in the last seven years. Yield seekers tend to be nervous money, and we could see massive outflows with no ready buyers if the markets start moving lower. REITS like Simon Property Group (SPG) , Boston Properties (BXP) , American Tower (AMT) , Vornado Realty Trust (VNO) , Essex Property (ESS)  and Digital Realty (DLR) appear to be overvalued at this level. They are definitely over-owned by large institutions right now. I would consider selling the shares if I owned them -- and would not even think about buying them at this level.

Infrastructure stocks got a huge boost last week on hopes of a huge spending campaign by the Trump administration. I love the idea and the long-term theme, but I think that many of the stocks are too pricey to buy at current levels. High multiple infrastructure stocks that have high levels of institutional ownership include Jacobs Engineering (JEC) , Martin Marietta Materials (MLM) , Vulcan Materials, and Fluor (FLR) . If there is any disappoint about the eventual outcome of the spending proposals, these companies could see a wave of selling that eliminates the bump they have received from the results of the election.

The stock market has had a great run since the bear-market bottom in 2009. It seems prudent to take a few minutes and check the level of institutional ownership in the stocks you own and consider selling those with the potential for forced selling if the world turns out not to be so perfect, after all.

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

TAGS: Investing | U.S. Equity | Financial Services | Real Estate | Transportation | Markets | Stocks

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