October 31st is Halloween, or “Hallowe’en”, and “All Hallows’ Eve”, a night when children – and adults – disguise themselves in colourful costumes or disguises. Originally it was to blend in with all the ghosts fairies, demons, imps and fae prowling the Earth on this one night when the veils between the worlds grew thin. Now, it’s more because dressing as a Minion or Wonder Woman is a lot of fun!
In our own little Halloween tradition, today we're profiling some spooky-expensive stocks. Despite the recent dip in the stock markets, there are more than 20 stocks in our coverage universe that are currently trading above their Fair Value Estimate. Five of them are trading at more than a 50% premium over our fair value estimate, making them almost as frightening as Jack Torrance wielding an ax.
These five stocks have a Morningstar Star Rating of either one star or two stars, which indicates that they’re overvalued. It is important to note that all the five have a Fair Value Uncertainty Rating of either ‘Very High’ or ‘High’. Morningstar’s Uncertainty Rating represents the predictability of the company's future cash flows and, therefore, the level of certainty we have in our fair value estimate of that company. “Some types of companies have less predictable cash flows than others and carry higher uncertainty ratings. Firms in more economically sensitive industries, including auto manufacturers, retailers, and restaurants, generally carry higher uncertainty ratings. So, too, do companies in highly disruptive sectors such as technology and communication services,” explains Morningstar.com’s director of content Susan Dziubinski.
It’s an eclectic bunch this time around, and given the uncertainty around the future cash flows of many of the companies listed here, there's a chance that our fair value estimates may be overly modest. But even once you take into account uncertainty, these names are still overpriced. Let’s look at the list, and three most expensive stocks in some detail:
| Name | Industry | Morningstar Star Rating | Fair Value Uncertainty | Price/Fair Value |
| Shopify Inc A | Software - Application | 1 | Very High | 2.19 |
| Barrick Gold Corp | Gold | 2 | Very High | 1.67 |
| Agnico Eagle Mines | Gold | 1 | High | 1.59 |
| Tourmaline Oil Corp | Oil & Gas E&P | 2 | Very High | 1.54 |
| West Fraser Timber Co. Ltd | Lumber & Wood Production | 2 | High | 1.49 |
Morningstar Direct Data as of October 26, 2020
The most expensive stock in our coverage universe in Canada has perennially been Shopify, and this time is no different. The stock has a ‘Narrow’ economic moat, and is trading at a whopping 120% premium to our fair value estimate. The next two are gold mining companies.
Gold Stocks Aren't Pure Gold
“Investments in gold stocks bring different return/risk drivers to a portfolio, as business decisions impact corporate revenues and cash flows. Additionally, due to the impact of leverage (both financial and operating), investments in gold stocks tend to be more volatile than the direct investment in the physical commodity. Importantly, these companies produce cash flows that can be valued,” says Morningstar Investment Management’s Global Head of Research, Philip Straehl in a recent report titled ‘Understanding Gold: An Expensive Insurance Policy?’
Investors seem to love the metal and want to buy, but we think it is not a good idea to invest in gold. We even busted the myth that you need to invest in gold – you don’t. Commodities like gold have little intrinsic value. Returns are governed by the balance of demand and supply, with a fair amount of speculation thrown in. These factors are extremely difficult, if not impossible, for retail investors to predict, so the chances of success are extremely low.
This does not bode well for a sustained rally in gold at these levels. Morningstar columnist John Rekenthaler in a recent column concluded that “If investing 10% in gold with a mainstream portfolio, use equities rather than bullion, because bullion lacks oomph. It is volatile by the standards of traditional investments but not enough to achieve the desired effect of diversification when used in a 10% dose. If investing 20% in gold, use bullion unless your risk tolerance is unusually high. Gold equities may lead to higher returns, but most will find the ride to be unduly bumpy.” Here’s the problem, though, if you want to buy equities, Canadian gold producers are not cheap. Which brings us back to our most expensive stocks – Barrick and Agnico.
Cash Moves Could be Canary in the Gold Mine
Morningstar equity analyst Kristoffer Inton expected this high price, noting that Canadian gold companies should enjoy significant free cash flow at these higher gold prices, which is what’s driven their rapidly rising share prices. “It’s notable that compared to previous gold rallies, we’re not seeing the miners going through a spending spree. This reflects hard lessons learned when gold prices rallied before and dropped thereafter, and miners then faced tough years of cutting back,” he adds.
To him, all gold miners look overvalued to us at this point, given that gold is more than US$1,900 per ounce and he forecasts midcycle prices of US$1,250 per ounce in today’s dollars. “No matter any individual operational improvements, their stocks are reflecting today’s high price in perpetuity. So a correction in gold prices would drive a drop in their share prices. Investing in gold miners is a levered bet on the gold price. When gold prices rise as they have, gold miners are going to rise by more. But it cuts both ways—when gold prices drop, gold miners are going to fall by more. Having a view on where gold prices go from here is going to be very important before buying any gold mining stocks,” he warns.
