Life is often about balance. You have to make sure that you don’t have too much, or too little of anything, and much of our lives is spent finding the right balance that works for us.
The same is true for investing. We often talk about stocks that are cheap and suggest stocks to buy. But when investing, one of the toughest things to know is when to sell a stock.
“Successful money managers make it sound so simple: Sell a stock once it has reached your estimate of its intrinsic value. But that’s easier said than done. What if the stock still looks cheap relative to others in its industry? Or if its story hasn’t entirely played out yet? Or if you worked for the company or were gifted the stock and therefore have some sort of emotional attachment to it?” asks Morningstar’s director of content Susan Dziubinski.
Though she concedes that there may be reasons to hold onto a stock even after it has reached fair value, she cautions that when a stock’s valuation is truly stratospheric, it’s time to let go.
So today, we looked for stocks that are not just overpriced, but very overpriced. Specifically, we looked for Canadian stocks that are trading at least 30% above our estimate of their fair values. We’re also looking for stocks with a medium Morningstar Uncertainty Rating. These stocks have more predictable cash flows, are easier to value, and, as a result, our analysts are quite confident in their fair value estimates.
Four stocks jumped out at us:
| Name | Price / Fair Value Estimate | Fair Value Uncertainty | Morningstar Rating |
| Gildan Activewear Inc | 1.57 | Medium | * |
| Metro Inc | 1.39 | Medium | * |
| Thomson Reuters Corp | 1.35 | Medium | * |
| CGI Inc Class A | 1.31 | Medium | ** |
Morningstar Direct data as of August 9, 2019
Gildan Activewear (GIL)
Fair Value: $31.5
Price: $48.8
Moat: None
Canadian apparel manufacturer Gildan Activewear is the top name on this list. It makes t-shits, fleeces and sports shirts under brands like Secret, Silks, Comfort Colors and the eponymous Gildan. It has invested about US$500 million in acquisitions since 2014, and has purchased a few notable brands, including Gold Toe (socks) and American Apparel (cheap fashion/printwear).
“We believe Gildan lacks a moat. We think its branded business has fallen victim to intense competition. While Gildan recently won a private-label men’s underwear contract with wide-moat Walmart, we think this product has largely replaced Gildan-branded underwear. We think Hanes and Fruit of the Loom have stronger innerwear brands, allowing them to hold significant shelf space at Walmart, no-moat Target, and other critical retailers,” points out Morningstar equity analyst David Swartz.
He attributes Gildan’s success in printwear to its cost-efficient production model, and notes that recent acquisitions have made it a stronger player in fashion basics, though he believes that Gildan's processes can be replicated by competitors and that cost savings is often lost to lower wholesale prices.
The stock is trading at close to 60% above our fair value estimate.
Metro Inc (MRU)
Fair Value: $38
Price: $53
Moat: None
With around 10% of market share, Metro is one of the largest grocery and drugstore operators in Canada. About 80% of sales are derived from grocery through various banners (Metro, Metro Plus, Super C, and Food Basics) with the remainder from pharmacy. In 2018, Metro acquired Jean Coutu, which expanded its pharmacy presence to around 20% of sales.
“Given the intensely competitive landscape and peers (Walmart, Costco, and Loblaw, to name a few) with vast resources, we expect profitability constraints to persist over our explicit forecast period, and we lack confidence that Metro will outearn its cost of capital throughout the next decade,” points out Morningstar senior equity analyst Dan Wasiolek. He forecasts Metro’s gross margins to falter toward 19.2% by fiscal 2028, down 50 basis points from 19.7% in fiscal 2018.
The stock currently trades at 39% above our fair value estimates.
Thomson Reuters Corp (TRI)
Fair Value: $66.5
Price: $88
Moat: Narrow
Thomson Reuters is a mass media, information and data services company. Going forward, the company will be divided into five segments: Legal Professionals, Corporates, Tax Professionals, Reuters News, and Global Print. The company no longer reports its results based on products but on customer type. Legal professionals now account for more than half of the company’s operating income.
Morningstar equity analyst Colin Plunkett considers the firm to be expensive despite its improving prospects, with the shares trading at more than 23 times his five-year forward estimate.
“It does appear that the company is achieving sustainable improvements in its growth profile. This is specifically noticeable in its corporate segment, which sells a mixture of its legal and accounting products to large enterprises. Overall, this quarter marks progress for Thomson Reuters and gives management’s strategy plenty of credibility, given the success of the Refinitiv divestiture and corresponding improvement in Thomson Reuters' remaining businesses,” he says. The stock is trading at a 35% premium to our fair value estimates.
CGI Inc Class A (GIB.A)
Fair Value: $77
Price: $101.1
Moat: Narrow
CGI is a Canada-based IT services provider with an embedded competitive position in North America and Europe. With more than $22.5 billion in its backlog, an average contract duration of six to seven years, and some of those contracts attached to clients that have been with the firm longer than 25 years, CGI has a solid operational foundation.
Morningstar equity analyst Andrew Lange expects to see more M&As in the next couple of years, which should help drive mid-single-digit long-term revenue growth. “CGI operates in a highly competitive industry and must contend with innovation, reputation, pricing, and staffing risks. As the company is an avid acquirer, integration risks could impede its future financial performance. The healthcare.gov contract exemplifies the risk associated with IT services work, and we think a string of such results could lead to significant reputation risk over time, which may lower client renewal rates. The firm's high exposure to government spending (approximately 33% of group revenue) also exposes it to government budgetary constraints,” he says.
The stock is trading at a 31% premium to our fair value estimates.
