5 Overvalued Investments

Published in Investing on 28 March 2011

Here's what you should be buying instead.

In the never-ending search for value, you have to be constantly on the look-out for overvalued investments, for speculative bubbles where prices have gone up and up, seemingly with unstoppable momentum.

But, of course, nothing is unstoppable. All bull runs end. All booms turn to bust. And when they do, inexperienced investors can get terribly burnt. Yet there seems to be something innate in human psychology which seems to draw us to bubbles like moths to a flame.

So here I will attempt to identify 5 current investments which are overvalued and which are potentially bubbles. And for each I will try to suggest more reasonably-priced alternatives.

1. India

India is a great investment story. The country has everything going for it: growth of 8% a year, good demographics, a host of emerging companies and a burgeoning middle class. And I have to admit I, personally, am kicking myself for not buying into this.

In 2006, and again in the depths of the credit crunch in 2009, India's Sensex 30 index stood at 9,000. At its peak in November 2010 it touched 21,000. Phew! That's an incredible 130% return in 18 months!

But if you've been keeping track of valuations, at the crest of this mighty bull run Indian stocks stood at a heady price/earnings ratio of 25. For comparison, the number for the Chinese stock market at the time was only 15.

Yep, it's true the Sensex has fallen back since then, but only to around 18,000 and a P/E ratio of 20. For me this is still way over-valued. I would steer clear of Indian shares until the P/E ratio is back down to the mid-teens.

The alternatives

Russia is currently at half the P/E ratio of India, and Brazil is only a little more expensive. If you want BRIC exposure, go for these markets instead.

2. Gold

You can't seem to pick up an investment magazine or the business section of a newspaper these days and not come across a tip for a hot gold mining stock, or an advert offering to buy your gold. Everyone wants to get a slice of the action. The euphoria over gold is a tell-tale sign of a bubble.

From my contrarian viewpoint, the time to buy gold was ten years ago, when it was priced at $250/oz, when everyone, including the UK government, was selling gold. Today the precious metal stands at over $1,400/oz, and everyone wants to buy gold. Would I buy at this price? Not in a million years.

The alternative

As the world economy continues to recover the demand for oil, a rather more useful commodity, will grow. As a holder of BP (LSE: BP) I am still a firm believer in this story.

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3. Mid cap stocks

Not much to say here except that in the last few years mid cap shares have outperformed both large caps and small caps. But this has resulted in relatively high valuations for mid caps. 

The FTSE 250 Index is at a P/E ratio of 17.5, as opposed to 13.7 for the FTSE 100 Index. This is the reverse of the situation a decade ago.

The alternative

It is time to rotate into large caps which currently are at very attractive valuations, with juicy dividends on offer too.

4. Tech shares

Aren't those iPads and 3DS's just so cool? 

Technology certainly is a wonderful thing. But, twelve years after the great tech bubble, which was followed by the horrific 'tech wreck', technology shares are heading towards bubble territory again.

And, in the UK, the company leading the tech charge is ARM Holdings (LSE: ARM), the microchip designer. It's a great British company which is growing fast, but as my fellow Fool Owain Bennallack has said, there's just one snag: the share price has already gone up six-fold in two years, and ARM is currently on a trailing P/E ratio of 55. 

To me, that is unsustainable -- this is an impressive company, but it is over-valued.

The alternative

If you are interested in investing in companies that are driving growth through scientific research, then a better value play is pharma and biotech. This is an unloved sector which undoubtedly has its difficulties but is, in my view, oversold.

5. Property

However, arguably the biggest bubble in the recent past has not been in stocks or commodities but is instead in a completely different asset class: property. The bubble has been slowly deflating since 2007. 

There was a rally in 2009-10, but don't be suckered into buying now. In my opinion, property is still over-valued, and the market will remain moribund for several years to come.

The alternative

Yep, you guessed it, shares! The good news is that, although there are areas of overvaluation, if you seek it out there is plenty of value to be found in many stocks and in many markets.

> Prabhat owns shares in BP.

 

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

BarrenFluffit 28 Mar 2011 , 2:14pm

I can understand how a sectoral p/e might lead to the conclusion that the sector is expensive but not based on a single company. I suspect investors are thinking that ARM is going to be Microsoft II.

ps200 28 Mar 2011 , 4:11pm

Hi BarrenFluffit,

I have focussed on ARM as it is one of the key tech stocks in the UK. But if you check the Nasdaq in the US, it is on a P/E ratio of 23.3, as opposed to 14.8 for the Dow. Perhaps I should have mentioned this in the article.

Cheers,

Prabhat.

DennyWhite 29 Mar 2011 , 12:35pm

Gosh, someone who wouldn't buy gold! You must be one of very few. What do you know that everybody else doesn't? A bubble tends to have no logic. There are fundamental reasons for holding and buying gold.

overanalyser 29 Mar 2011 , 1:47pm

If you're expecting the oil price to rise then BP isn't a very good way to profit from it, it's business model is fairly balanced to avoid being affected by the oil price significantly. To profit from oil rising you should by an oil explorer and/or producer. The fool is one of the best places for discovering and discussing such companies!

dougie186 29 Mar 2011 , 2:19pm

Here,here - stay with gold. Certainly, oil has a big future, but I wouldn't back BP. Recent performances have been bad, and until they treat others with more respect, BP will be dogged by Bad Performances. Maybe this is something you don't know or do not wish to know.. .

supersol42 29 Mar 2011 , 2:58pm

There are those who have valued the current worth of gold at over $3,000....

Meanwhile, over in the states, it is only a matter of time until Wall Street twigs what is happening in the rest of the country.

Afrosia 29 Mar 2011 , 3:15pm

How do I value gold? If I can't value it then I'm not interested. I can tell you what will make it move, but valuing it is beyond subjective!

Afrosia 29 Mar 2011 , 6:57pm

People calling for gold prices of $22,300 stinks of bubble to me!

It isn't a currency, it's a shiny metal. Calm down please.

If you ask me whether I'd rather invest in a shiny metal or the ingenuity and creativity of the human spirit then I know what I'll choose.

Phsycho 29 Mar 2011 , 8:02pm

"How do I value gold? If I can't value it then I'm not interested. I can tell you what will make it move, but valuing it is beyond subjective!"

Subjective? You can value gold, the same way is has been valued for centuries long before the FTSE, and now on our over sensitive and over analysed markets the same way as any other commodity.

Even Blue chips can crash and burn. Gold never has , never will.

So to have some gold in a diverse portfolio is very sensible.

ClassicGemini 29 Mar 2011 , 8:11pm

Only $22,300? I really can't tolerate these miserable doomsayers!!

Gold will rise to at least $50,000 an ounce, and in about 5 years, not 10!!

Anyone who denies this is just a sad loser who hasn't got my vision and therefore doesn't deserve to become a millionaire like what I will!!

Gold is good!!

2hindy 29 Mar 2011 , 8:26pm

i have just put prabhat sakya on ignore what a load of garbage,did he get paid for that article,i visit the motley fool
less and less now,the standard of reporting is terrible

Afrosia 29 Mar 2011 , 9:16pm

So how do I value it then? What method do I use?

Anyone got a step-by-step guide to gold valuation? So that my grandmother can understand it please.

ABMorley 29 Mar 2011 , 9:57pm

Why is gold valuable? What use is it? OK some gets used in industry, but most of the gold ever dug up seems to get buried again in vaults. I don't understand its intrinsic worth.

(Platinum, OTOH, is a very useful metal in industry. Houses you can live in, food you can eat... but gold?)

bdh198 29 Mar 2011 , 10:17pm

Investing in India, Mid Cap Stocks, Tech Shares and Property you can invest smartly and still make money even if that class of investment is generally weak.

If you've invested in Gold then if the bubble bursts you're in trouble.

Another possible overvalued (investment bubble)... wine?

abrahamisaacs 30 Mar 2011 , 1:07am

I DID buy gold ten years ago when everybody was selling. I bought mostly gold krugerands at the time - easy to buy and easy to sell. BUT although I got the timing perfect, I did not buy a meaningful enough quantity for it to make much difference to my financial position. I had around £3000 in krugerands but got nervous having them in my drawer in case they were stolen. So now when I buy something I really believe in, I buy a meaningful amount.

Iamb4ne1 30 Mar 2011 , 12:10pm

I've heard that gold will be at more than $1 million an ounce within the next 300 years.Buy and hold!

Plucky23 30 Mar 2011 , 12:34pm

Hello everyone, this is my first post since I joined the fool some months ago. I am looking for long term investments with as much growth and returns as possible. I feel that anything which continues to grow such as gold cannot be sustainable although saying that I do not see that the oil price is likely to fall unless new technologies can take its place, which I do not see happening within the short term.

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