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2 Overbought Stocks That Could Plunge

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You’ve probably heard the saying that it “never hurt” to take a bit of profit off the table.

While it is a good idea to sell the stocks that have soared above and beyond your estimated fair-value range, in many instances, it’s a better idea to hang onto your winners so that they can keep on winning. Hyper-growth stocks like Shopify have always been expensive, yet shares have continued to defy the laws of gravity. And if you sold your shares after their big run a few years ago, you lost out on significant upside.

When it comes to lower-growth firms that don’t have the means to post triple-digit sales growth numbers, though, it does make sense to do some selling after an overextended rally, especially if there’s nothing exciting to look forward to like in the case of many tech darlings like Shopify. This piece will have a look at two such overbought low-growth names that could be ripe for a pullback, as the broader growth-to-value rotation runs out of steam.

Consider Loblaw Companies (TSX:L) and Empire Company (TSX:EMP.A), two Canadian grocers that have been soaring in 2019 as investors gravitated away from cyclical names and into consumer staples in preparation for a recession, which may or may not happen anytime soon.

Over the past year, Loblaw and Empire have soared 30% and 50%, respectively, not because they’re leveraging game-changing technologies that could disrupt their boring, low-tech industry, but because investor appetite for recession-resilient names have been steadily increasing with all the uncertainties and recession fears that have plagued this market.

While both companies would fair well in the event of a severe economic downturn, the stocks of both grocers could also correct sharply over the near term should recession fears be put to rest.

At these valuations, you’re paying a slight premium for the recession-proof traits of the grocers, and if it turns out we won’t fall into recession, after all, a considerable chunk of the gains enjoyed by the “boring” grocers could be surrendered in a hurry. So, unless your portfolio is severely lacking in defensive names, I’d sell the grocers and look elsewhere for your downside protection.

Moreover, with continuing to make noise in the grocery arena just south of the border, a threat of a more aggressive move into Canada could pose a severe threat to Canada’s incumbent grocers, as margins are already absurdly thin.

At the time of writing, Empire and Loblaw trade at 17.1 and 15.2 times next year’s expected earnings, respectively. Not insanely expensive by any means, but with a potential long-term headwind in Amazon and a lack of meaningful growth prospects, investors should demand a much wider margin of safety.

Stay hungry. Stay Foolish.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Fool contributor Joey Frenette has no position in any of the stocks mentioned. David Gardner owns shares of Amazon. The Motley Fool owns shares of Amazon and Shopify. Shopify is a recommendation of Stock Advisor Canada.

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