Flood of Downgrades Shows Valuations Are More Than Just Stretched
A sudden downpour of key analyst downgrades before third quarters earning season suggest a correction.
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The markets continue to hover near all-time highs as investor complacency remains in plain sight. Warren Buffet’s favorite valuation metric for the overall market, stock-market-overall-capitalization-to-U.S.-GDP ratio, clocked another record high this week. Meanwhile, third quarter earnings season is ready to flood the wires with Q3 results in the coming weeks.
One thing I have noticed heading into earnings season is there seems to be more notable analyst downgrades in recent days into the deluge of third quarter reports about to hit the wires. BTIG cut American Express AXP on Wednesday from a Buy to Sell. It expects the credit card giant to follow Ally Financial ALLY and note that consumer conditions are worse than they anticipated in the second half of 2024. The same day, HSBC cut American Express to a Hold due to valuations being considerably above their 10-Year average.
On Monday, Barclays cut Netflix NFLX to an Underweight based primarily on concerns that valuations had become detached from the company’s likely growth path. That same day, Amazon AMZN got a rare ratings downgrade from Wells Fargo from Overweight to Equal Weight, mainly on concerns around margins.
My favorite ratings downgrade of the week came from KeyBanc Securities, which downgraded Sherwin Williams SHW to a Sector Perform based on valuations. It wasn’t the downgrade that necessarily caught my eye as much as the fact that other analyst firms haven’t already taken this action given the stock’s valuation. This is a paint and coatings manufacturer and retailer that trades at north of 30-times forward earnings and provides an under 1% dividend yield. Sales are predicted to average 2% to 3% growth in the next couple of fiscal years. Not only does the earnings valuation appear absurd, but the stock trades at a higher price-to-sales ratio than at any time in recent memory.
I am not picking on Sherwin Williams. It is a fine company and, when I repainted my loft a few years ago, they got my business. It is just a poster child to how stretched valuations have become in this market. Too many investors seem to believe that a few cuts to the fed funds rate is going to be a panacea to all that is wrong with the economy.
You can see this in housing where home builders like D.R. Horton DHI are trading at their highest price-to-book ratios in at least 15 years. DHI’s book value of just over 2.4-times is more than twice as much as two years ago even as existing home sales remain moribund, and housing affordability is hovering near historical lows. Yes, mortgage rates have ticked down a bit in recent quarters. However, this is not going to trigger a housing boom in the foreseeable future.
I am happy to see at least some analyst firms appearing to be getting more cautious. I hope more join them in the coming weeks given the current valuations around the overall market.
At the time of publication, Jensen had no positions in any securities mentioned.
