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The Association of U S West Retirees
 

 

 

Give Thanks, Then Get Started Selling Those Overvalued Stocks
By James B. Stewart
The Wall Street Journal
Wednesday, November 22, 2006

Investors certainly have plenty to be thankful for this week when they sit down to their holiday feasts.

Maybe the recent rally seems even more savory because it's been so unexpected. But this isn't the time to worry about why the market keeps hitting highs in the face of a housing slump, slower growth and an inverted yield curve. It's a time to enjoy it.

This is one major reason I'm constitutionally unsuited to be a bear. Imagine that you'd been shorting the market, rooting for a big drop, and now are cranky about the money you've lost while everyone else has cause to celebrate.

But once thanks are given, it may well be time to take action. With the Nasdaq Composite at about 2450 this week, the index is approaching my latest selling threshold of 2515, when it may well be time to lock in some of these recent gains. That means the Nasdaq has gained almost 25% since the summer correction.

As it turns out, I've already consulted my list of overvalued stocks, based on the formula I've described that combines recent price appreciation with price-to-earnings growth, or PEG, ratio. Since writing about the virtues of the proposed CVS/Caremark deal, I've been itching to buy CVS shares. This is one situation I feel strongly about, which doesn't mean I'm right.

Since my recommendation, CVS shares have gone nowhere, but the broad market has kept ascending to new highs. Last week I decided there was no point in waiting for a substantial correction. Even though I'd never increase my exposure to stocks in a market this frothy, it's all right to add positions as long as I sell something else. That's what led me to my list of overvalued stocks.

In checking options prices for CVS, I was pleased to discover that there was only a very small premium if you're willing to buy in-the-money calls. (A call is an option to buy a security at a specific price.) With CVS at $29, I bought the January 2008 calls with a strike price of $25 for just over $5. With CVS shares currently trading near $28, the spread had widened slightly, and those calls were quoted at $5.70. The January 28 calls with a strike price of $20 had an even lower premium. To pay for those calls, I sold calls on stocks that looked pricey and offered big call premiums.

So what was on the list? At the very top is SonicWall, which makes network-security software, firewalls and email-security software. It's already up nearly 40% this year -- not a bad showing, but more to the point, it boasts an off-the-chart PEG. Don't ask me why. All I can say is that if I owned this stock I'd be running for the exits.

Also rounding out the top 10 are such well-known names as Qwest Communications International, Sun Microsystems and Akamai Technologies. Akamai has nearly tripled this past year. My advice: Don't be greedy. These are prime candidates for profit-taking. (When you run the data for your own overvalued list, your results may differ with the shifting prices. I ran this screen last week.)

Not surprisingly, plenty of commercial real-estate investment trusts were on the list. Notwithstanding Blackstone's proposed $20 billion buyout of Equity Office Properties Trust, the data support my view that many REITs are overvalued. In this latest deal, my money would be with Sam Zell, a shrewd investor who I suspect smells a market peak in this sector.

Some other familiar names on the list (in descending magnitude of being overvalued) include Krispy Kreme Doughnuts, Celgene, AMR, Merck, Marvel Entertainment, Dillards, Comcast, and Campbell Soup. Conspicuously absent were energy companies (plenty were on the list earlier this year) and financial concerns. And, needless to say, drugstore chains like CVS.

James B. Stewart, a columnist for Smart-Money magazine and SmartMoney.com, writes weekly about his personal investing strategy. Unlike Dow Jones reporters, he may have positions in the stocks he writes about. For his past columns, see: www.smartmoney.com/wsj_common.

http://online.wsj.com/article/SB116415923221130234-search.html?KEYWORDS=Qwest&COLLECTION=wsjie/6month