My approach to sell-side analysis is as follows: while most stocks in your portfolio will provide some returns over an indefinitely long period, there is almost always "good value" to be had somewhere in the market. Thus, with a few exceptions (like "buy-and-hold-forever" stocks like Coca-Cola (NYSE:KO)), I believe that if individual stocks no longer classify as a "good value," it may be time to sell. These stocks' pricey valuations suggest unexceptional future performance, which may interfere with your ability to achieve high returns -- why not look for better value elsewhere?
Please note that my analysis below is not necessarily a recommendation to short. Do so at your own risk -- after all, "he who sells what isn't his'n must buy it back or go to pris'n." Even if a company is clearly overvalued, the market can remain irrational long enough to rack up significant losses for short-sellers.
With that in mind, here's one stock that caught my eye as being potentially overvalued.
Wendy's (WEN) is a well-known fast food chain. While I must admit that I do like their spicy chicken nuggets every once in a while, I'm a little less enthused about their stock. Here's why.
- Premium valuation. Wendy's P/E is 58.6. Compared to a P/E of about 16 on McDonald's (NYSE:MCD), it's hard to believe the Wendy's valuation is justified on any level. (Is Wendy's intrinsically worth 4x more than Golden Arches? I think not.)
- Wendy's forward PEG ratio (5-year projected) is 4.18. Again, unjustifiable valuation.
- Wendy's forward long-term EPS growth, at 14%, doesn't look positively awful -- but again, it doesn't justify sky-high valuations.
- Wendy's isn't particularly efficient. Wendy's gross margin is 25% (vs 45% for McDonald's). Wendy's profit margin is a dismal 2%, compared to 19% for McDonald's.
- As could be expected from margin, Wendy's return on equity is a very sad 1.5%. For comparison, McDonald's has a return on equity a few basis points above 38%.
- Wendy's chart shows flat multi-year price action. While I typically like buying discounted, beaten down stocks, you'll notice from the chart below that Wendy's dropped off a cliff after the financial crash and it's never really recovered. I'll buy dips (temporary weakness) but you'll have a hard time selling me on a stock that looks so bad just from the chart.
I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.