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These Four Stocks Look Overheated

After a robust rally, stocks look fairly valued overall, but these names still look richly priced.

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The market rally since the March lows has been nothing short of breathtaking. Investors have cheered as the possibility of a second Great Depression ebbs and looser credit markets and economic indicators show signs of a nascent recovery. The rally has been sustained recently by second-quarter earnings reports that were generally better than horrific expectations (though most reports were still dreadful in an absolute sense). Management teams also fueled optimism by saying they see stabilization in the global markets, though few are reporting any signs of meaningful growth.

Despite all of these positive signs, there is still a ton of uncertainty and much to be worried about in the economy. Consumer confidence remains low, job losses are starting to decelerate, but still more than 500,000 people a week are filing new unemployment claims. Individuals and businesses are in the midst of a massive deleveraging process that could take years to unwind. Consumer spending tends to be a major impetus to economic recovery, and it is hard to see how that is going to turn strongly positive anytime soon.

There are also long-term concerns about the impact of the unprecedented monetary easing and fiscal stimulus currently sloshing through the economy. This money has helped stabilize the economy, but it could lead to higher inflation and an unsustainable budget deficit. Who knows if the economy will be able to maintain its trajectory when the federal government takes its foot off the pedal.

With so many moving parts, it isn't surprising that the rally has also not been consistent across sectors. Although all are up year to date, some have had a much bigger rise. Financial Services led the way with a 53.12% gain, followed closely by the Hardware and Industrial Materials sector. Check out the table below for all sector's total returns or visit the performance tables for more info.

Sector NameYTD1-Month3-Month1-YearFinancial Services53.1224.5825.73-17.69Hardware49.7815.1915.71-8.55Industrial Materials48.9217.6615.85-16.91Energy38.3911.348.47-16.07Consumer Services35.3611.828.65-4.09Software33.19.5819.76-7.87Business Services27.516.0516.69-8.69Media22.3915.267.82-16.72Telecommunications20.29.9812.55-15.16Consumer Goods18.39.512.18-20.63Health Care11.438.7618.37-12.39Utilities8.565.3114.14-19.69

Data as of 8/6/2009

But is this rally sustainable, or are stocks set to tumble again? In aggregate, our team of stock analysts believes that the market is currently fairly valued. And although we wouldn't attempt to prognosticate the short-term movements of the stock market, it appears that fundamentals broadly support current levels of valuation.

This doesn't mean that every stock is fairly valued. Given the expected tepid pace of recovery and the long-term challenges facing the economy, scores of firms have run up in price too far, too fast and are now rated 1-star. We used the  Premium Stock Screener to find 1-star stocks in sectors that have had the biggest gains. Here are four names that passed. Although in some cases, we think the business prospects for these firms are bright, we believe investors are taking quite a bit of stock price risk by investing at current levels. Click  here to run the screen for yourself.

 ASML Holding NV (ASML)
1 star | Economic Moat: None | Fair Value Uncertainty: Medium
From the  Analyst Report: ASM Lithography is the top provider of tools used in the most critical semiconductor fabrication process. The in-depth technological expertise required to make these tools helps protect the firm's strong competitive position. Although ASML is the leader in the lithography market, the firm is in the midst of a cyclical downturn that is afflicting the entire chip-equipment industry.

 Donaldson Company (DCI)
1 star | Economic Moat: Narrow | Fair Value Uncertainty: Medium
From the  Analyst Report: Donaldson leads the technology curve for industrial and engine filters and has been deliberately expanding its reach across the globe. We believe this narrow-moat firm will continue to deliver solid returns on invested capital and be a steady performer through the rough economy.

Because Donaldson's filters are consumed during the manufacturing as well as the transportation process, the firm is not immune to economic cycles across the world. The bright spot for Donaldson is that environmental regulations make it very difficult for firms to curb spending altogether on Donaldson's products.

 Pentair (PNR)
1 star | Economic Moat: Narrow | Fair Value Uncertainty: Medium
From the  Analyst Report: Pentair's focus on its water businesses has helped to build both scale and experience in the competitive space. Although the firm's principle end markets are at a virtual standstill, there are significant tail winds that make for a brighter future for Pentair.

Roughly two thirds of Pentair's revenues come from the water segment, which is driven by residential and commercial construction, as well as municipal spending. As a result, cash flows are rather sensitive to the state of the overall economy. There are signs that competition might be growing in Pentair's filtration markets, leading Pentair to seek partnerships with GE and ITT.

 James River Coal Company (JRCC)
1 star | Economic Moat: None | Fair Value Uncertainty: Very High
From the  Analyst Report: James River Coal Company declared bankruptcy in March 2003 as a result of rising industry costs and long-term contracts priced well below the market. The small Central Appalachian coal mining firm emerged with a fresh start in May 2004, and strong industry fundamentals suggest the outlook for James River is brighter today. Still, given the firm's past missteps and the challenges the industry is facing, we believe James River will have difficulty generating economic profits in the long run.

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