In a new blog post, Susan Dziubinski, Morningstar’s director of content, wrote that “there are plenty of reasons that people hold on to stocks longer than they should. But most agree — at least in theory — that when a stock’s valuation reaches nosebleed levels, it’s time to sell.”
Morningstar has a more nuanced take on the matter.
Dziubinski noted that a common metric for evaluating whether a stock is under- or overvalued is the price-earnings ratio, that is, a stock’s current price divided by the company’s 12-month earnings per share. A forward P/E uses a company’s mean earnings-per-share estimate for the next fiscal year in the denominator.
“While P/E is certainly a widely accepted yardstick for measuring whether a stock is over- or undervalued, it’s not always the best,” Dziubinski wrote.
Morningstar’s analysts use a different method to value stocks. They focus on calculating a stock’s fair value estimate, which represents intrinsic value based on expectations of a company’s future cash flows.
If a stock’s price is below that fair value estimate, it is undervalued in their view.
In a new screen, analysts looked for stocks that were overvalued according to their P/E ratios, yet were undervalued according to Morningstar metrics.
Specifically, they targeted stocks whose forward P/Es were more than twice that of the Morningstar U.S. Markets Index, but whose star ratings were in the 4- and 5-star range. (They excluded extreme uncertainty stocks from the mix, given the difficulty of accurately estimating the future cash flows of such companies.)
Thirteen stocks made the cut. Although these stocks may look like candidates for selling given their P/Es, Morningstar analysts argue otherwise.
See the gallery for the stocks with high P/Es that you probably shouldn’t sell, according to Morningstar.
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