The market finally took a breather in January. After a remarkable rally from its lows in March 2009, most major indexes were down last month. The S&P 500 and the Dow lost more than 2% and the Nasdaq was off by more than 3.5%.
This pullback was not completely unexpected. At the beginning of the month our analyst staff thought that stocks were about 4% overvalued. This is a far cry from the almost 40% undervaluation the analysts saw in March. From a valuation standpoint, the furious rally looks over. The economic recovery, and subsequent recovery in corporate earnings, is already priced into shares, and returns look set to be much more subdued going forward.
But just because the rally has cooled off doesn't mean that all shares are starting to look more attractive. Throughout the last year, we've had trouble understanding the exuberance that the market has shown to some stocks. There are now 42 stocks that have a Morningstar Rating of 1 star, which means the they are in the Consider Selling range. Our analyst staff thinks that 13 of these firms will likely leave current shareholders with nothing. These companies range from embattled media firms such as McClatchy (MNI) to mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE).
But most of the 1-star-rated stocks are businesses that the market is simply overvaluing. It could be that investors are overestimating how fast earnings can increase during the recovery, or they are too aggressively discounting the possibility of a liquidity crisis. To find a list of these stocks, we used the Premium Stock Screener to find shares that are rated 1 star but that have a fair value estimate not equal to zero. Here are a few firms that passed. Run the screen for yourself here.
ARM Holdings (ARMH)
Moat: Narrow | Uncertainty: High | Total Return YTD: 4.67%
From the Analyst Report:
We think ARM Holdings has a narrow economic moat and a highly scalable business model.
