Even though Jim Cramer's trades are not long-term recommendations, his picks can be a very useful barometer of investor and media attitudes. Contrarians can use his picks as an indicator of current market sentiment to selectively counter.
Of Cramer's 64 buy and sell stock opinions recently issued on CNBC's Mad Money (three shows between 1.16.2011 to 1.20.2011), buy calls for Chipotle Mexican Grill (NYSE:CMG), Panera Bread (NASDAQ:PNRA), Whole Foods Market (NASDAQ:WFM) and American Tower (NYSE:AMT) do not make sense on a valuation basis:
Market Cap ($Millions)
The price-to-earnings, price-to-book, and price-to-sales valuation multiples are high for each of these stocks. In addition, insiders are selling more shares of CMG, WFM and AMT than they are buying. Thus, from a static valuation perspective, these are clearly unattractive stocks.
What's more, these stocks seem overvalued even after incorporating high growth projections.
What could an investor expect from these picks? Total returns over a 3-year holding period for each of these stocks. (I use a 3-year holding period since above-average growth estimates are not reliable further out.) Giving these buy recommendations the benefit of the doubt, each stock is assumed to be sold at a generous growth stock price to earnings multiple of 17 and the maximum of historical and analyst estimate values for earnings growth are assumed. These assumptions are used to project an annualized total return over the next 3 years and a terminal price to earnings ratios, that is, price paid today divided by earnings at the end of the holding period for each stock:
3 Years Growth
Even when incorporating fantastic earnings growth, these stocks are just too expensive.
These projected returns flip the script on these four buy calls. They ignore stories and current sentiment, and use valuation and math to demonstrate how buying expensive stocks can cost investors dearly.
Bear in mind that challenging the consensus requires guts of steel. Contrarians have to shut out the allure of stories, interviews in the financial media and other distractions in order to focus on valuation. This is quite difficult.
Disclaimer: This article was written to provide investor information and education, and should not be construed as a guarantee or investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing. I repeat: this research does NOT constitute a guarantee.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.