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After a strong rally over the last five months the market now stands at four year highs. Given the continuing unfolding crisis in Europe, I think the market should have at least a decent pullback at some time over the coming few months. One sector that looks increasingly vulnerable is the tech sector, especially those stocks with stretched valuations that have had great runs over the last few months. Here are three I would avoid at these levels. For more aggressive investors, they should be considered as short candidates.

Rackspace Hosting (NYSE:RAX)

Business description from Yahoo Finance (see here):

Rackspace Hosting, Inc. operates in the hosting and cloud computing industry. It provides information technology (IT) as a service, managing Web-based IT systems for small and medium-sized businesses, as well as large enterprises worldwide.

4 reasons RAX is overvalued at $47 a share:

  • The stock is selling at the top of its historical valuation range based on P/E, P/CF and P/S.
  • The stock is priced at over 6 times revenues and has a five year projected PEG of 2.38.
  • The median analysts' price target is one dollar over its current price level at $48 and the stock has a forward PE of over 58.
  • Revenue growth is not accelerating and earnings estimates for FY2012 have remained static over the last two months even as the stock has had an impressive rise. The stock looks like it is ready for a breather.

Note: If an investor is looking for a play on the secular trends of expanding data needs and server expansion/optimization I would recommend EMC Corp (NYSE:EMC). It is the leading provider of data management solutions and owns 80% of VM Ware (NYSE:VMW), the leader in server virtualization. It also has a valuation that is much more appealing.

Fortinet (NASDAQ:FTNT)

Business description from Yahoo Finance (see here):

Fortinet, Inc., together with its subsidiaries, provides network security appliances and unified threat management (UTM) network security solutions to enterprises, service providers, and government entities worldwide. Its primary UTM solution consists of FortiGate appliance products that provide a range of security and networking functions, including firewall, VPN, antivirus, intrusion prevention, application control, Web filtering, antispam, wireless controller, and WAN acceleration.

4 reasons FTNT is to be avoided at $25 a share:

  • The stock has tried and failed at this price level several times in the last eight months (see chart, click to enlarge image):

  • It has a five year projected PEG of 2.38 and sells at almost 10 times revenues.
  • The stock has run up some 60% since its lows of October and now is priced at around 42 times forward earnings.
  • 66 times trailing earnings seems very expensive for a stock who analysts project will grow earnings and revenues at just under 20% in each of the next two fiscal years.

Aspen Technology (NASDAQ:AZPN)

Business description from Yahoo Finance (see here):

Aspen Technology, Inc., together with its subsidiaries, provides integrated process optimization software solutions for manufacturers in process industries, and engineering and construction firms. It designs and develops aspenONE suite software applications for use in the engineering, manufacturing, and supply chain business areas.

4 reasons AZPN is no bargain at $20 a share:

  • The stock is selling at the top of its historical valuation range based on P/CF, P/S and P/B.
  • Insiders have sold almost 30% of their shares over the prior six months and it is selling at more 9 times revenues.
  • The stock is selling at almost 100 times the 23 cents analysts project it should earn in FY2013.
  • It is selling near its 52 week high and has risen over 25% in the last month. It also has only turned into one quarter of positive earnings in the last six quarters.

Disclosure: I am long EMC. I also may go short AZPN in next 72 hours.

Source: 3 Tech Stocks Deep In Overvalued Territory