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Commentary

4 Stocks That Look Expensive

As stocks hit levels not seen in years, these four firms look too rich for our taste.

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The market truly has been on a rampage so far this year. The broad-market Morningstar US Market index is up almost 12% year to date, and this week, many of the major stock indexes hit multiyear highs. The S&P 500 broke through the 1,400 barrier, the Dow is comfortably over 13,000, and the Nasdaq is at levels not seen since 2000. 

The rally isn't completely an exercise in irrational exuberance. There has been a string of better-than-expected news from the U.S. economy from jobs data to retail sales. Furthermore, the latest Greek-debt deal has helped mute some of the tail risk of a massive blowup in Europe. Add in some decent corporate earnings, and it isn't hard to see why investors are wading into the market again.

But to contrarians, new highs are usually worrying, even if economic data are looking a bit better. Particularly now, the level of uncertainty in the economy remains at well-above-average levels. Rising gas prices are threatening to derail consumer spending. Europe might be doing better, but it is far from out of the woods. The U.S. still has big fiscal imbalances, and corporate management teams seem to be somewhat skittish.

This is not to say that stocks are wildly overvalued. They aren't. Morningstar's equity analysts think stocks are around 3% undervalued on average. But the big margins of safety that investors could count on in the middle of 2011 are long gone. Security selection--making sure you are buying high-quality companies at cheap prices--has become even more important. Investors need to be extra diligent in making sure the fundamentals of any given business justify the valuation. Additionally, investors would also be well-served by making sure that those fundamentals have the ability to stand up in a wide variety of economic conditions; making a bet that a stock will pay off only if there isn't another economic downturn is risky business.

To find these stocks that are now priced to economic perfection, we used Morningstar's  Premium Stock Screener to find equities that our analysts assign a Morningstar Rating for stocks of 1 star. Unsurprisingly this list has been expanding as the market has risen, but here are four stocks that passed the screen. Premium members can see the complete list by  clicking here.

 Barnes & Noble (BKS)
Economic Moat: None | Uncertainty: Very High 
Pete Wahlstrom writes in his  Premium Analyst Report:
Barnes & Noble has proven to be a solid operator in the retail bookseller space, relative to its brick-and-mortar peers, and continues to navigate a challenging environment fairly well. The company has been quick to act in a changing market, through the creation of loyalty programs, the launch of its eBookstore platform and proprietary eReader (the nook) and, in late 2009, the acquisition of B&N College Booksellers. The firm has grown into the largest physical bookseller, with more than 1,300 locations across the United States, and an online standing inventory of more than one million unique titles. Plus, operational efforts have generally paid off in the form of higher inventory turns and cash flows that are meaningfully above Borders , its closest brick-and-mortar competitor (which filed for Chapter 11 protection in February 2011 and is in liquidation). However, sobering statistics (low margins combined with high fixed costs and inventory requirements) underscore core challenges facing the book business. In our view, it will be difficult for the company to build an economic moat in this industry.

 Estee Lauder (EL)
Economic Moat: Narrow | Uncertainty: Medium
Erin Lash writes in her  Premium Analyst Report:
With the wind at its back and a fresh perspective from an outsider at the helm, Estee Lauder has realized accelerating sales growth and margin expansion, which has resulted in significant stock price appreciation during the past year. We don't deny the impressive strides that the global beauty-care firm is making, but unlike the market--which appears to assume that Estee Lauder's current trajectory continues into perpetuity--we are skeptical as to whether this pace of improvement is sustainable.

 ASML Holding (ASML)
Economic Moat: Narrow | Uncertainty: Medium
Andy Ng writes in his  Premium 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. However, ASML must contend with the notorious cycles of the chip-equipment industry over time.

 Old Dominion Freight Lines (ODFL)
Economic Moat: None | Uncertainty: Medium
Matthew Young writes in his  Premium Analyst Report:
Old Dominion ranks among the top 10 domestic less-than-truckload carriers by revenue. The $40 billion-plus LTL industry is a bit more complex and asset-intensive than full-truckload shipping because LTL carriers specialize in moving smaller shipments from multiple customers quickly, usually on a day-definite basis. Such operations require a network of service terminals for cross-docking activity, where a carrier can consolidate shipments from several customers for additional linehauls or final delivery. Because of the scale required to cover a sizable fixed cost base, the LTL market is more concentrated than that of the truckload market--the top 15 providers account for more than 60% of industry revenue. Nonetheless, the remainder of the market remains highly fragmented. This dynamic, coupled with the commodified nature of LTL services and low switching costs, makes for a fiercely competitive operating environment that breeds profitability erosion in periods of soft demand, as seen during the recent freight recession.

Data as of March 15, 2012. 

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