The stocks I think have the potential to beat high-flyers like CSL Limited and A2 Milk Company Ltd

The share price of two of Australia’s favourite stocks has just gotten more expensive, even a portfolio manager at Perpetual Limited (ASX: PPT) complained that the stocks are too expensive in an interview with the Australian Financial Review.

But that didn’t stop CSL Limited (ASX: CSL) from jumping 1.3% to $160.02 and A2 Milk Company Ltd (ASX: A2M) from adding 0.9% to $12.22 during lunchtime trade. Both stocks are hovering near record highs.

There is a more important issue at the heart of this observation that I will cover later. But first, the surge in their share prices reflect a big shortcoming on our market.

According to Perpetual, investors are being forced to pay top dollar for quality stocks with solid earnings outlooks because there are too few of these stocks listed on the local exchange run by ASX Ltd (ASX: ASX).

The expert believes CSL and A2 Milk are overpriced because you can buy overseas stocks with similar businesses and customers on much lower multiples such as Hong Kong-listed China Mengniu Dairy and London-listed Shire.

Even if these companies have a lower earnings growth profile, they still represent much more attractive options given the large gap in valuation between the ASX-listed and offshore-listed stocks.

The irony is that Australian companies often complain that the valuations of their overseas rivals are higher than the multiples local investors are willing to cough up.

But what is perhaps more significant about Perpetual’s observation is that buying bargains (or value stocks as the experts like to call them) have not been a particularly rewarding strategy over the past year or so.

Stocks like CSL, A2 Milk and Altium Limited (ASX: ALU) have never been classified as cheap but they have delivered some of the best returns on our market. It is these expensive stocks that dominate the league table.

But this is actually to be expected for this part of the bull market cycle. Value stocks don’t typically do well until the late stages of the bull market and I think we are approaching that part of the cycle as I believe sentiment will turn decidedly negative towards the latterr part of this calendar year or in 2019.

This isn’t the time to be quitting equities though. Far from it. But what it does mean is that this is probably the time to take some profit from these big winning trades and start looking at stocks with a positive earnings outlook but have been underperforming the S&P/ASX 200 (Index:^AXJO) (ASX:XJO).

It’s stocks like Nufarm Limited (ASX: NUF) and Webjet Limited (ASX: WEB) that I think will offer the best returns over the next several months.

But there are other stocks that are also well placed to outperform the market this year, according to the experts at the Motley Fool. These stocks will benefit from a big investment thematic that is expected to hit the market over the medium to longer-term.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of A2 Milk and ASX Limited. The Motley Fool Australia has recommended Webjet Ltd. 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 Scott Phillips.

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