Given the S&P 500’s 7.3% year-to-date advance and the threat of a recession in the second half of the year or early 2024, overvalued S&P 500 stocks are more prevalent than investors realize.
At the end of February, JPMorgan Chase strategists suggested that because of real interest rates, stocks were 2.5 times too expensive. “Risk-reward for equities remains poor in our view, reinforcing our underweight equity stance,” JPMorgan strategist Marko Kolanovic said.
The index is up 3.8% since those comments were made.
Of the 503 stocks in the S&P 500, approximately 160 are up more than the index YTD. Of those, 22 are up 30% or more. That’s where you’ll find some of the most overvalued S&P 500 stocks to sell.
Using cash flow and free cash flow valuation metrics (price-to-sales and price-to-cash flow), I’ve selected three overvalued S&P 500 stocks to avoid or sell.
| WST | West Pharmaceutical Services | $369.62 |
| ALGN | Align Technology | $306.84 |
| ANET | Arista Networks | $134.98 |
West Pharmaceutical Services (WST)
West Pharmaceutical Services (NYSE:WST), which provides its healthcare clients with injectable solutions, drug delivery systems and other proprietary products that enable them to develop and bring life-saving drugs to market, is up 57.1% YTD. It currently has price-to-sales and price-to-cash-flow ratios of 9.6 and 39, respectively. Both metrics are at or above their five-year average.
Another metric I use to assess fair value is free cash flow (FCF) yield, defined as trailing 12-month (TTM) FCF divided by market capitalization. As of Q1 2023, West’s TTM FCF was $410 million. Based on a market cap of $27.5 billion, it has an FCF yield of 1.7%. I consider anything below 4% to be potentially overvalued.
In the first quarter of 2023, organic sales rose 2.3% to $716.6 million, while its operating cash flow decreased by 8.7% to $138.1 million. Those are hardly inspiring numbers.
Analysts aren’t sold on West Pharmaceutical. Of the 11 analysts covering it, only five rate it “overweight” or “buy,” with an average target price of $359.25. That’s 2.8% below where it’s currently trading.
Align Technology (ALGN)
Align Technology (NASDAQ: ALGN) lost more than 10% on April 27 after it reported disappointing Q1 results. Yet, even with the double-digit percentage post-earnings drop, shares of the maker of Invisalign teeth aligners are still up 45.5% on the year.
The company reported first-quarter sales of $943.1 million and net income of $140.6 million. While revenue and net income were up on a sequential basis, they were down 3.1% and 21%, respectively, on a year-over-year basis, thanks in part to higher expenses.
Shares are trading at 6.7 times sales and 33.5 times cash flow. While those are lower than its five-year averages, growth has slowed substantially from 2021.
In the first quarter of 2023, Align’s case volume was 558,563 (clear aligner constant currency net revenue of just over $768 million divided by revenue per case shipment of $1,375), 6.7% less than the 598,800 in Q1 2022.
Investors ought to be worrying that this stock’s best days were during the pandemic.
Arista Networks (ANET)
Cloud networking company Arista Networks (NYSE:ANET) was doing very well on the year heading into its first-quarter earnings report on May 1. Shares were up 32% YTD and 142% over the past five years. Yet, despite reporting earnings and revenue beats, shares fell nearly 16% in May 2 trading, lowering the stock’s 2023 gain to 11.2%.
On the top line, revenue of $1.35 billion was $40 million higher than analyst expectations. On the bottom line, it earned an adjusted $1.43 a share, 9 cents better than the consensus estimate. Additionally, its Q2 revenue guidance was higher than the analyst estimate.
So, what is it that has investors selling?
In a conference call with analysts, management admitted that big cloud companies such as Microsoft (NASDAQ:MSFT) and Meta Platforms (NASDAQ:META) had driven demand for its cloud infrastructure products.
“We expect some moderation in customer spending, especially with our cloud titan customers following a year of accelerated demand in 2022,” Chief Financial Officer (CFO) Ita Brennan said.
Prior to announcing, shares were trading at 11.6 times sales. That’s been cut to 8.4 as a result of the post-earnings sell-off.
One analyst who thinks Arista is a buy after the sell-off is Needham’s Alex Henderson. Barron’s reported his comments to clients on May 2, with the analyst saying he views this decline as “an opportunity to Buy a best-in-class company.”
I don’t see it that way. You can expect sales to slow in the second half of 2023. While the risk/reward proposition got a little better on the sell-off, ANET remains one of the overvalued S&P 500 stocks that’s likely to fall further in 2023.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.