Although the bulk of the top 20 largest stocks in the S&P/ASX 200 (Index: ^AXJO) (ASX:XJO) have underperformed the broader market during 2015, there have been a number of high quality, blue chip stocks in the index that have performed exceptionally well.
It can be tempting to buy these stocks in the hope they will continue to rise but this can be a strategy fraught with danger.
Here are my top three stocks that I think are over-valued and at risk for a pull-back in 2016:
- Blackmores Limited (ASX: BKL) – Blackmores has been the top performer in the index for 2015 but it now looks well and truly fully valued. I am a big fan of the company and I believe it has a bright future but I find it difficult to justify paying a multiple of 40x earnings (FY16 estimated) in an environment where competition could begin to intensify. Any minor issue will see the share price come under huge pressure.
- Qantas Airways Limited (ASX: QAN) – Qantas has successfully implemented its cost-cutting program and has benefited greatly from the capitulation of the oil price. This has resulted in the share price increasing by more than 70% in 2015. Despite the dramatic turnaround in the company’s profitability, the difficulty in forecasting earnings means investors have to hope everything remains in favour of Qantas to continue this trend – something I wouldn’t be banking on.
- Sydney Airport Holdings Ltd (ASX: SYD) – I remain a strong believer in Sydney Airport’s long term growth potential but I believe the share price could come under pressure over the next 12 months. Although passenger numbers have been increasing steadily thanks to the huge influx of Asian tourists, an expected rise in bond yields could have a dramatic impact on the company’s $6.7 billion debt burden. In addition to this, the unfranked dividend yield is now less than 4%.
In contrast, here are three stocks that I think could still deliver great returns for investors over the next 12 months:
- Macquarie Group Ltd (ASX: MQG) – Macquarie has returned to the winners’ circle over the past couple of years as it has successfully diversified its investment banking operations. The company is now truly global and is Australia’s largest asset manager by a fair margin. In addition to this, Macquarie has been aggressively acquiring new bolt on businesses and at the same time developing new financial products. The company is expected to deliver solid earnings growth in FY16 and the shares appear attractively priced at less than 14x analysts’ forecasts. Investors can also expect a dividend yield of around 4.5%.
- Ramsay Health Care Limited (ASX: RHC) – Ramsay has been one of the best performing stocks on the market for many years and has justifiably earned the valuation premium it currently trades at. The company is now the largest private hospital operator in France and Australia and has a global pipeline of new developments to add to its existing portfolio. Ramsay will deliver another year of double-digit earnings growth in FY16 and is well placed to take advantage of the long term trends in the healthcare sector.
- REA Group Limited (ASX: REA) – It has been a turbulent year for shareholders of REA Group but the share price has rebounded nicely in the second half of the year. The company has been the dominant provider of online real estate listings in Australia for many years and is now focusing its attention on the much larger global market. REA Group has recently made some important strategic acquisitions including an offer for iProperty Group Ltd (ASX: IPP). A successful move in global markets could very well see the share price trade substantially higher than it is now, although it is a stock that carries a higher than normal level of risk at its current valuation.
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Motley Fool contributor Christopher Georges owns shares in REA Group and Ramsay Health Care. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.