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Stock Strategist

The Market's Most Overvalued Stocks

There's still time to sell these stocks even after the recent market decline.

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After peaking in mid-July, the S&P 500 has lost about 5%. Because our fair value estimates are less volatile than stock prices, we've seen an increase in the number of stocks with 5-star Morningstar Ratings and a corresponding decrease in the number of 1-star stocks among the 1,900 stocks Morningstar covers.

The percentage of stocks trading above our 1-star (Consider Selling) price has fallen from 24% to its current 14%, which represents about 250 companies. In fact, the median stock covered by our equity analysts now trades at a 4% discount relative to our collective fair value estimates. (Click to see our current Market Valuation Graph.)

In our previous article on the market's most overvalued stocks (see if you own any of those companies), we focused on extremely overvalued stocks, most of which traded at several times our estimates of their intrinsic values. In this installment, we instead highlight stocks that have already had a rough year but remain overvalued based on current market prices relative to our fair value estimates. To generate the list of companies at the bottom of this article, I used Morningstar's Premium Stock Screener to narrow the stock universe to companies trading above our Consider Selling price that have fallen by more than 15% for the year to date and that have more than $1 billion in market capitalization ( click here to run this screen). Before discussing why some of these companies might be overvalued, let's first address the difficulty that comes with selling a losing position.

Selling Winners Is Easy
All investors like to make money, and locking in a return by selling a stock for more than you paid creates a paper trail that essentially says "I was right." Some of us like to refer to these gains when our self-esteem wavers because a losing position has cast doubt on our stock-picking prowess. (For now, we'll ignore the fact that many investors sell their winners too soon.)

In contrast, selling losers is very, very hard. Nobody likes to be the greater fool who paid more for a stock than what the market says it's currently worth. Most people, stock investors especially, aren't programmed to readily say "I was wrong," which is essentially what selling a losing position admits. But sometimes selling poorly performing stocks is the rational thing to do (and not just for the tax write-off). It's our belief that the long-term losses that come from hanging on to bad positions for too long are far worse than the short-term anxiety that comes with cutting ties.

Two Wrongs Don't Make a Right
There are times when investors are wrong to buy a particular stock in the first place and wrong again to not sell it once they realize their initial mistake. Instead, many investors will irrationally hold on to this loser, hoping for a fortuitous appreciation in the stock price that will allow an opportune and profitable sale. However, more often than not, not only do two wrongs not make a right, they can become extremely costly in the long run.

Jet Blue Airways (JBLU) is a prime example in the making. The stock is down about 33% from the start of the year, which has undoubtedly been painful for a lot of investors. Most likely, there are some shocked shareholders who still naively cling to their positions under the assumption that the stock has finally bottomed. However, our fair value estimate indicates that there's probably more shock to come, as the stock would have to fall almost 40% further to be properly valued. The year-to-date stock price and fair value estimate chart below vividly shows this relationship.

Here are a few more stocks in situations similar to Jet Blue's, and they're listed here from most overvalued to least overvalued. We recommend fighting the urge to hang on to these falling shares and move on to currently undervalued companies. According to our analysts, there are 230 stocks cheap enough to buy today. ( Click here to see the list of stocks trading below our 5-star--Consider Buying--price.)

 Sirius Satellite Radio (SIRI)
Industry: Radio
Premium to Fair Value Estimate: 100%
From the  Analyst Report: "We think Sirius' greatest challenge is competing with terrestrial radio, which costs nothing and is still available on satellite radio hardware. However, other competition looms as well. Apple (AAPL), the maker of the popular iPod digital music player, has announced deals with several automakers in which the player will be integrated in the stereo systems of new cars. Content accessed through cell phones and wireless networks capable of streaming Internet radio in the car may sound far-fetched today, but the way people consume media is constantly evolving."

Jet Blue Airways Corporation (JBLU)
Industry: Air Transport
Premium to Fair Value Estimate: 61%
From the  Analyst Report: "Some of JetBlue's cost advantages will eventually erode. For one, the firm recently began flying 100-seat Embraer 190s. With the Embraer 190, JetBlue intends to target regional routes with higher pricing yields, but the yields might not entirely offset the higher unit costs associated with this smaller plane. Plus, JetBlue will incur incremental pilot training and maintenance costs with the addition of this second airplane type to its fleet of Airbus A320s. In general, as its young fleet of airplanes ages, more frequent and thorough maintenance will add to unit costs. JetBlue's labor expenses will grow as the workforce accumulates tenure, and JetBlue is not immune to the threat of unionization."

Apartment Investment & Management (AIV)
Industry: Real Estate Investment Trust
Premium to Fair Value Estimate: 49%
From the  Analyst Report: "We believe Apartment Investment & Management's (Aimco) portfolio is not positioned to take full advantage of favorable trends. The company's large affordable housing division sets rent levels in concert with government agencies that may be reluctant to pass on hefty increases to tenants. Even Aimco's market-rate apartments are mostly in subprime locations and of middling quality, making it more difficult to demand premium rents."

SL Green Realty Corporation (SLG)
Industry: Real Estate Investment Trust
Premium to Fair Value Estimate: 37%
From the  Analyst Report: "Though we like SL Green's diversification efforts, we don't think they go far enough. First, the company's newly acquired suburban portfolio is less than 15% of the total holdings. Second, tenant concentration remains high; the top 25 tenants account for a sizable 42% of total rents with the largest tenant (Viacom International) accounting for 8% of total rents. Finally, just three Manhattan buildings account for 28% of annualized rent."

Greenhill & Co. Inc (GHL)
Industry: Finance
Premium to Fair Value Estimate: 36%
From the  Analyst Report: "Greenhill & Co. has had a great run since 2003; the question facing the firm and its investors is how much longer the good times will last. Investment banking is a cyclical business, and at some point the rapid pace of merger and acquisition activity will eventually slow and the tailwind that Greenhill has benefited from will start blowing in the other direction. The strong relationships between Greenhill's bankers and its clients generate a narrow economic moat for the firm, but the firm will be challenged to maintain its current growth rates over the long run."

UDR, Inc. (UDR)
Industry: Real Estate Investment Trust
Premium to Fair Value Estimate: 33%
From the  Analyst Report: "Condo sales have been a bright spot for UDR, but we think the good times are over: The first-time buyers UDR is trying to attract will likely be kept out of the market by rising mortgage rates. Slowing condo sales should boost demand for apartment rentals. Still, the decline in condo sales and the decreased likelihood that UDR can dispose of properties at expensive prices will likely make the company's restructuring process more painful."

Alaska Air Group, Inc. (ALK)
Industry: Air Transport
Premium to Fair Value Estimate: 28%
From the  Analyst Report: "Alaska Air Group operates two subsidiaries: Alaska Airlines, a mainline carrier, and Horizon Air, a regional affiliate ... Though Alaska and Horizon serve different air travel needs, both are exposed to the industry's structural faults, which include cyclicality, intense price competition, commodified services, low barriers to entry, high barriers to exit, and elevated fixed costs. We think these attributes make managing operating costs paramount, especially in an environment in which real yields (average fare prices) have been under pressure for decades."

 First Marblehead Corporation (FMD)
Industry: Finance
Premium to Fair Value Estimate: 22%
From the  Analyst Report: "A superficial look at the financial statements suggests First Marblehead is incredibly profitable, but deeper investigation reveals some concerns. The company's reported earnings are largely noncash, and operating cash flow has averaged only 41% of net income during the last three years. First Marblehead recognizes all of the income a securitization generates during its life at the time the securitization is closed. We do not view earnings as high quality when they're based on predictions of what will happen 20 years from now. Given the company's limited operating history, we think its estimates must be greeted with some caution."

Joel Bloomer does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.