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4 Overpriced Large-Cap Stocks

These stocks are all expensive based on their prices relative to Morningstar’s fair value estimates.

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Remember when the sky was falling, just two short months ago? By mid-February, stocks were down 10% for the year to date. According to Morningstar’s Market Fair Value Graph at that time, the market’s price/fair value dipped as low as 0.86, meaning that the median stock on Morningstar's coverage list was 14% undervalued.

Fast forward to today. As of this writing, the market is in the black for the year to date. And, not surprisingly, the market is back to being fairly valued according to our price/fair value metric.

Given the reversal, we wanted to find out which stocks were most overvalued today. Specifically, we were interested in overpriced large companies, because these are the firms held by most stock investors.

Using Morningstar's Premium Stock Screener, we screened on stocks landing in the large-cap area of the Morningstar Style Box trading at least 25% above their current fair value estimates. We also insisted the stocks carry Fair Value Uncertainty Ratings of Medium or Low, ensuring that we zeroed in on companies whose fair value estimates our analysts were most confident in.

Ten stocks made the cut. Premium Members can view or adapt the entire screen  here. Four of the most overvalued large-cap stocks are listed below.

 Aetna (AET)
Rating: 1 star
Price/Fair Value: 1.43
Fair Value Uncertainty: Medium

This well-known managed-care organization, or MCO, earns a narrow moat, and should be able to use its scale to effectively manage its fixed costs and negotiating position, says analyst Vishnu Lekraj. He also thinks Aetna can expand its membership base and build its operational advantages through its acquisition of  Humana (HUM), which is on track.

Nevertheless, the MCO industry faces too many headwinds for Aetna to be as richly priced as it is today. 

"As a result of greater regulation and fewer profitable growth prospects for the market, the aggregate investment outlook for managed-care organizations is uncertain," writes Lekraj. "Greater competition, ACA mandated profit caps, and available membership growth only from lower profit cohorts will weigh on the sector."

 Adidas (ADDYY)
Rating: 1 Star
Price/Fair Value: 1.42
Fair Value Uncertainty: Medium

Trading 42% above our fair value estimate as of this writing, Adidas is among the most dearly priced large caps we cover. The narrow-moat company, best known for its Adidas and Reebok products, remains one of the elite brands in performance sportswear and apparel, says analyst Paul Swinand. Moreover, the company's first-quarter sales were robust, and management increased its outlook for 2016.

Nevertheless, Adidas can't boast the same scale advantages and price leadership as Nike, and it's facing increased competition from the likes of Under Armour.

"We still see Adidas shares as trading at a premium to our fair value estimate even after the strong first-quarter 2016 results," says Swinand. He estimates that Adidas would have to sustain double-digit operating margins and 2 percentage points higher long-run revenue growth to justify its current stock price. 

 Constellation Brands (STZ)
Rating: 1 Star
Price/Fair Value: 1.41
Fair Value Uncertainty: Medium

This narrow-moat maker of wine, spirits, and beer has put up some impressive income growth numbers, thanks in large part to above-market gains in its beer business. Sector director Adam Fleck believes the firm will deliver continued solid earnings growth in 2017. In addition, the company plans to build a new brewery closer to the U.S. and has entered into a glass plant joint venture to reduce glass manufacturing and freight costs. Those moves should allow it to improve its already strong operating margins.

That said, Fleck expects capacity additions to dampen free cash flow for the next few years. Moreover, he says the double-digit volume growth rates of recent quarters are unlikely to persist over the long run, given more-challenging year-over-year comparisons.

"The shares look substantially overvalued," concludes Fleck.

 Public Storage (PSA)
Rating: 1 Star
Price/Fair Value: 1.40
Fair Value Uncertainty: Medium

The largest owner of self-storage facilities in the United States, narrow-moat Public Storage has profited from favorable industry trends. 

"Beginning in 2010, employment levels, the housing market, and mobility of the population began to improve, resulting in Public Storage's current stretch of outstanding performance," notes sector director Stephen Ellis. A one-two punch of increasing storage demand with constrained supply benefited existing self-storage landlords.

The tide may be slowly turning, however. Large developers like Public Storage have begun to construct new facilities, which will lead to an increase in supply. 

"We also expect demand to moderate somewhat as the macro environment decelerates,"adds Ellis. Ellis therefore expects some slowdown in the next three years, which has been built into our $188 fair value estimate.

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