3 Overvalued Stocks to Buy on Pullbacks

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The stock market has been hitting all-time highs over the past couple of years, and as a result, investors have become rather optimistic that that the uptrend will continue. This has also led to investors into overvaluing many companies.

For conservative investors who are looking to put money to work this can be frustrating, and it can be tempting to just bite the bullet and buy the stock of a company you like at a high price. But this can be costly in the long run, and there are two reasons for this. The first is that stocks are a volatile asset class. While investors may be optimistic in today’s market, this may not be the case in six months to a year. But in all likelihood, the companies you wish to invest in will be more or less the same. With the knowledge that eventually investors will be pricing in a more pessimistic scenario for the companies you want to buy, it makes sense to wait for a pullback.

The second is that waiting for even a modest 10 to 20 percent pullback may not seem like a big deal now, but it can pay off enormously over the long term as your gains compound. This is especially true if the company you wish to invest in is buying back its own stock or is paying dividends that you are reinvesting. That 10 to 20 percent can wind up making more than a 100 percent difference, and all of a sudden waiting makes a lot of sense.

So in what follows I highlight three great companies that I think will generate returns over the long run. You will probably do well even if you buy them today, but if you wait for a correction, you will do substantially better.

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1. Visa (NYSE:V)

Visa is actually a stock that I own, but at a much lower price, and I would not buy it today.

Visa is the leading cashless transaction facilitating company, and it stands to benefit from the global trend toward greater credit card and debit card use. The company has strong, stable growth that can continue through a recession. It also generates a large profit margin that has been steadily rising as the company finds more ways to increase efficiencies.

Right now the stock trades at about 23-24 times next year’s earnings, which doesn’t seem expensive considering this bullish case. However, the company’s growth has been slowing somewhat as of late: It is more difficult for Visa’s management to grow earnings as it becomes a larger company. Nevertheless, this is a stock worth picking up in the $180 range, which would be about a 15 percent correction from here.

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2. Union Pacific (NYSE:UNP)

Union Pacific has been the second fastest-growing American railroad company. It has been growing in the double digits, and it hasn’t had to face one of the problems that its East Coast counterparts have been dealing with these past few years — declining coal shipments. Furthermore, the company has a rapidly growing Mexican business that adds to its overall growth.

However, the shares trade at 18.3 times next year’s earnings estimates. Analysts seem to think that there is no stopping the company’s growth. But keep in mind that railroads are cyclical businesses, as great as they are, and this outlook can change very quickly if the economy starts to turn lower. It follows that the downside risk doesn’t seem to be priced in at the current valuation, and while current shareholders shouldn’t sell, it is a bad time to buy. Investors should wait for a pullback to the 200-day moving average, which is at about $87 per share. Right now, the stock trades at about $100 per share. This would put the stock at a valuation of about 16 times earnings, which I think is far more reasonable.

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3. Yum Brands (NYSE:YUM)

Yum Brands has been a great way for investors to get exposure to emerging market growth, and Chinese growth in particular. Kentucky Fried Chicken is an extremely popular restaurant chain overseas. Furthermore, the company has recently begun to see rising sales again after it had to deal with a PR snafu that led consumers to question the safety of the company’s food.

Unlike many other fast food companies, Yum Brands has been able to grow in a tepid economic environment, and it has been able to maintain and even grow its strong profit margins despite rising food prices. This makes the company a winner in the fast food space.

However, the stock is overvalued. While the company’s growth was enormous last quarter, keep in mind that this was coming off a lousy 2013, and so growth going forward should slow to the mid-teens. The stock currently trades at 32 times trailing earnings and at 22 times forward earnings estimates. I think this is steep. Consequently, I think investors should wait for a pullback to about the $65-$70 per share range so that the stock is trading at around 18-19 times earnings. This is a much better entry point, and investors who wait will be happy that they did.

Disclosure: Ben Kramer-Miller is long Visa.

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