We've previously warned investors about the dangers of trusting Wall Street's opinion. It's #4 on our list of 5 Classic Mistakes Individual Investors Make. We've even suggested that it can be used as a contrarian indicator.
Today, we're bringing you three stocks recently upgraded by Wall Street that are both significantly overvalued and are businesses with poor economics.
Each of these stocks are overvalued according to a discounted cash flow valuation, using a 15% discount rate.
Normally, we'd say that we hope you'll use this list as a starting point for your analysis, but genuinely, we hope you don't, unless you're looking for short candidates.
1. Aluminum Corporation of China Ltd. (ACH)
ACH produces alumina, primary aluminum and aluminum fabrication in China.
It's delivered positive net income for nine out of the past ten years, which is impressive. But, if you look even the slightest bit deeper, you can see that's not the real story.
ACH has actually been losing money. This is because it's an extremely capital intensive business. Its Capex-to-Net-Income ratio has been significantly above 100% for the past 8 out of 10 years, and one of those 2 years where it wasn't, it was at 98.56%. This means that all of its so-called profits are going to capital expenditures, thereby pushing the free cash flow to bleed into the red for the past 9 out of 10 years.
On top of that, it's overvalued:
Growth Price (DCF): $12.02
Current Price: $23.36
ACH is overvalued by 94.34%.
Vuru Grade: 39.63/100
The Vuru Grade is our proprietary grading system, which has been fine-tuned to deliver strong results and provide accurate assessments of the quality of stocks.
As you can see, ACH has a low Vuru Grade and rightly so.
It blows our collective mind that any Wall Street analyst would upgrade this to anything above a Sell. We're looking at you Goldman Sachs (source).
2. Calgon Carbon Corporation (CCC)
CCC provides products, services and solutions for purifying water and air.
This is a typical mediocre business in a highly competitive industry. As it's in the cleantech space, its financial statements might start to see some growth as demand for those types of products are increasing. However, it takes a big leap of faith to say that its bottom line is going to improve so significantly to make up for the 279.12% gap between its value and its current price, and go beyond that...
Growth Price (DCF): $4.55
Current Price: $17.25
CCC is overvalued by 279.12%.
Vuru Grade: 34.15/100
Janney Capital (source), we just don't see it. The risk/reward ratio is out-of-wack on this one. Why take this risk when you can buy proven, high-quality companies at a significant discount to their value?
3. CSX Corporation (CSX)
CSX provides rail-based transportation services, including rail service and the transport of intermodal containers and trailers.
The bullish case for this stock is that higher diesel prices are going to drive manufacturers towards rail transportation instead of trucking. As pointed out by David Fessler, the Federal Railway Administration stated that,
the average rail fuel efficiency is anywhere between 156 and 512 ton-miles per gallon of diesel. On the other hand, the average truck fuel efficiency is 68 to 133 ton-miles per gallon.
We admit it's a compelling case as oil prices aren't likely to drop significantly in the near future.
However, CSX is a highly capital intensive business. It's posted positive net income for the past 10 years, but its profits have been eaten up by capital expenditures. Free cash flow has been negative for the past 3 out of 10 years.
For CSX to stay competitive, it must spend large amounts of capital buying new equipment or investing in new facilities. With it losing money all over the place, it remains to be seen how it can continue at this rate without taking on substantial debt.
Additionally, the stock's price is way above its intrinsic value.
Growth Price (DCF): $48.51
Current Price: $78.62
CSX is overvalued by 62.07%.
Vuru Grade: 34.08/100
Only with significant growth of its bottom-line can CSX be deemed 'fairly valued' at its current price. As a result, it's difficult to see why Stifel Nicolaus has boosted CSX from a 'Hold' to a 'Buy' (source), as expectations of profit growth seem to already be built into the price.