Caution! These 3 Stocks Are Overbought After the November Rally.
At the end of September, long-time MarketWatch contributor Mark Hulbert wrote a piece that argued the S&P 500 was still overvalued despite a recent 6% correction. Since that article appeared, the index has gained another 5%, suggesting the November rally has produced several overbought stocks.
Hulbert’s article pointed out that the average price-to-sales and price-to-earnings ratios were 2.41 and 23.08, respectively, as of Sept. 25.
So, excluding the Magnificent Seven, I’m looking for three S&P 500 stocks that have gained more than 5% since Sept. 25 and have P/S and P/E ratios higher than the averages for the index.
Finviz.com shows 156 S&P 500 stocks with a P/E of 25 or higher and a P/S ratio of 3.0 or higher.
From this group, excluding the Magnificent Seven, I’ve chosen three overbought stocks from three sectors.
Chipotle Mexican Grill (CMG)
Chipotle Mexican Grill (NYSE:CMG) stock is up 62% year-to-date. Its P/E and P/S are 51.9 and 6.5, respectively.
While there is no question that Chipotle is one of the best restaurant operators in the country, its stock has come a long way in 2023. It’s also come a long way in the past five years, up 370% — 6x the index over the same period.
One valuation metric I use to assess whether a stock is overbought is free cash flow yield, defined as the trailing 12-month(TTM) free cash flow (FCF) divided by enterprise value.
Chipotle’s TTM FCF as of Q3 2023 was $1.39 billion. Based on an enterprise value of $63.5 billion, it has an FCF yield of 2.2%. I consider anything below 4% to be overvalued.
I like Chipotle a lot. However, wait for its price to correct below $2,000 in the next 6-12 months.
Arista Networks (ANET)
Arista Networks (NYSE:ANET) stock is up 81% year-to-date. Its P/E and P/S are 36.3 and 12.4, respectively.
The networking stock lost some wind in its sails in mid-November after Cisco (NASDAQ:CSCO) reported a slowdown in new orders due to a two-quarter backlog in shipped products.
“‘For value investors that can be patient, the upside here is Cisco can do $4.50 to $5 EPS (earnings per share) post Splunk and stock can work to the mid 70s though patience is needed,’ they said. They lowered their price target to $55 from $63.”
KeyBanc analysts believe Cisco is the value play in networking stocks. Cisco’s P/S ratio is 3.4, while its P/E ratio is 14.6, 2.5x less than Arista’s valuation.
So, the question for investors is whether Arista is overbought or Cisco is oversold. I would suggest it’s a little of both.
Analysts are mixed about ANET stock, with 17 analysts out of 27 covering it, giving it an Outperform or outright Buy. The target price of $225.10 is just 2.9% higher than where it’s currently trading.
Of tech stocks in the S&P 500, ANET is the 6th-best performer in 2023. This, more than anything, suggests it’s overbought at the moment.
Copart (CPRT)
Copart (NASDAQ:CPRT) stock is up 66% year-to-date. Its P/E and P/S are 37.1 and 12.3, respectively.
The company started in 1982 with a single salvage yard in California. Twelve years later, it went public in 1994 at $12 a share. Today, it is a global leader in online vehicle auctions, with operations in 11 countries from more than 200 locations worldwide.
Extremely profitable, its Q1 2024 net profit was $332.5 million, or 32.6% of its $1.02 billion in revenue. It sells most of its vehicles on behalf of insurance companies that have written them off after an accident or natural disaster. It gets paid in two ways: sales transaction fees through its auction platform (83% of revenue) and by purchasing vehicles, remarketing them, and selling for a profit (17%).
There’s no question that it provides a much-needed service for insurance companies. So, there’s almost no chance that its services will go out of style anytime soon.
Its P/S ratio is 22% higher than its five-year average of 10.1. Its enterprise value of $46.3 billion is 26.7x its EBITDA, considerably higher than its five-year average of 23.1.
Based on the TTM FCF of $901.7 million, it has an FCF yield of 1.9%, well below the 4% minimum I look for to determine reasonable value.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
