Last April I introduced my own stock valuation formula, dubbed TMFULOI, because I was tired of living by Wall Street analysts' rules. My formula, which you can read more about by clicking here, utilizes the Motley Fool CAPS Screener and data from Morningstar to take into account a company's price-to-book, price-to-sales, and price-to-cash flow, to determine which companies are the most overvalued.

My very first experiment with the TMFULOI proved quite successful, with all five companies heading lower over the course of a two-month period and four of five underperforming the S&P 500. The second group of overvalued companies, unveiled last June, didn't perform as well as the first group; however, it's still quite evident that the TMFULOI appears to have some substance based on these results:

Company

Performance Since
June 12, 2012

Performance Relative to S&P 500

LinkedIn

72.2%

57.4%

Alexion Pharmaceuticals

(8.8%)

(23.6%)

Baidu

(20%)

(34.8%)

Gold Resources

(48.8%)

(63.6%)

SolarWinds

21.6%

6.8%

Source: Yahoo! Finance, author's calculations.


LinkedIn once again proved to be the primary thorn in my side, but overall, with the S&P 500 up 14.8% during the period, this group of companies underperformed the broad-based index by an average of 11.6% per company!

Therefore, the time has come once again to unveil the next group of overvalued companies according to my formula and see if I can make it three-for-three! As usual, I've excluded royalty trusts and clinical-stage biotechnology companies, as they'd significantly skew the results. In addition, I've got a new twist that I've added to the index that should help factor in growth prospects rather than penalize companies for their high ratios and give me/us a better understanding of just how overvalued these companies are.

The latest stock screen run on Motley Fool's CAPS Screener turned up 19 companies, of which the six below qualified under the TMFULOI parameters:

Company

Price/
Book

Price/
Sales

Price/
Cash Flow

TMFULOI

LinkedIn

21.1

21.7

82

124.8

ARM Holdings 

11.3

23.8

64.5

99.6

Aspen Technology 

26.9

10.4

21.7

59

SolarWinds

11.3

16.1

30.1

57.5

MercadoLibre 

13.7

10.3

33.2

57.2

Tile Shop Holdings

18.1

13.1

15.9

47.1

Source: Morningstar, author's calculations.

The aforementioned new twist, which comes from the suggestion of a flaw in the original TMFULOI formula by my Fool colleague Rick Munarriz back in June with regard to Baidu, is that I plan to divide the TMFULOI value by the forward year's estimated revenue growth as determined by Wall Street to get a newly adjusted TMFULOI value that factors in growth.

Company

Price/
Book

Price/
Sales

Price/
Cash Flow

TMFULOI

Forward
Sales
Growth %

Adjusted
TMFULOI

ARM Holdings

11.3

23.8

64.5

99.6

19.6%

5.08

LinkedIn

21.1

21.7

82

124.8

38.9%

3.2

Aspen Technology

26.9

10.4

21.7

59

19.1%

3.09

SolarWinds

11.3

16.1

30.1

57.5

22.7%

2.55

MercadoLibre

13.7

10.3

33.2

57.2

22.4%

2.53

Tile Shop Holdings

18.1

13.1

15.9

47.1

24.1%

1.95

Sources: Morningstar, Yahoo! Finance, author's calculations.

ARM Holdings
ARM Holdings produced the second-highest TMFULOI value, but, based on the recently added growth factor, is hands-down the most overvalued company out there according to my formula. ARM has been relying on its stable lead in mobile and tablet processing IP architecture over the past couple of years, but could be "priced to perfection" according to technology guru and Fool colleague Evan Niu. Evan noted in January that ARM's royalty rate per unit has been on an almost precipitous decline since 2006. While this doesn't put ARM in any danger of losing its IP superiority in mobile devices, it could continue to slow down its growth rate, which may spell disaster at such lofty valuation multiples.

LinkedIn
Yes, LinkedIn's back for a third go-around, and I have to say I'm hoping for a best out of five, because it's beaten the TMFULOI index two rounds running! LinkedIn's fourth-quarter earnings results vaulted its share price significantly higher despite projections of 45% revenue growth from management this year and a tapering to 38.9% according to the Street's estimates in 2014. I won't deny that LinkedIn's management is making smart moves to attract reader clicks by focusing more on business news, or that most of its metrics are heading in the right direction, but it's a simple matter of whether or not LinkedIn can support a price-to-cash flow of 82 -- and resoundingly I'd say, "No!"

Aspen Technology
Aspen, a designer of optimization, conceptualization, and supply-chain management software, is another new addition to this list. Aspen has been clicking on all cylinders since the recession, but it's struggled to produce big profits as it's spent much of its cash flow from operations on R&D and retiring its now paid-off short-term borrowings. Shares roared higher in late January when it, like LinkedIn, soared past relatively tame estimates. However, according to statistics available on Morningstar, every valuation or margin metric would be considered worse than the industry average. At 76 times forward earnings and -- generously extrapolating its cash flow through the first six months -- 28 times 2013's projected cash flow, I'm not that impressed.

SolarWinds
Thus far, Fool Rex Moore's analysis of SolarWinds has kicked my valuation formula's behind, with SolarWinds also holding the unique distinction of actually producing a higher TMFULOI score in all three screens to date. The IT management software company's "freemium" model that spurs customers to try out its software has been extremely cost-effective and resulted in top-notch margins. However, as I stated in June, I can't see its peers, like Cisco Systems, letting SolarWinds' business model go uncontested and would presume they'll slowly work their way into SolarWinds' niche. Revenue growth is also slated to decelerate from 36% in 2012 to a range of 23% to 26%, according to management in 2013. I'm once again calling this valuation unsustainable.

MercadoLibre
Last, but certainly not least in the pricey column, is MercadoLibre, the so-called "eBay of Latin America." As with ARM, the reason that the company's shares are so pricey somewhat makes sense given that there's less e-commerce saturation in the emerging markets of Latin America and thus plenty of potential. However, MercadoLibre is also forced to spend quite a bit on expansion costs in order to support its operations in these emerging markets -- all while revenue growth is modestly slowing. I don't consider MercadoLibre a "strong sell" per se, but it clearly will need pristine earnings results this week in order to maintain its valuation.

Foolish roundup
For this third round of selections, we'll check back in a few months and see where I stand. I fully expect to go three-for-three in comparison to the S&P 500, and look forward to a touch of reality rearing its head in all five cases.

With Baidu now off the TMFULOI radar, is now the time to buy?
Regardless of your short-term view on the Chinese economy, there may be opportunity in Baidu (aka the "Chinese Google"). Our premium report breaks down the dominant Chinese search provider's strengths and weaknesses. Just click here to access it now.

The article 5 Stocks You Can Sell Right Now originally appeared on Fool.com.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool owns shares of Baidu, Tile Shop Holdings, Cisco Systems, and eBay. Motley Fool newsletter services have recommended buying shares of Baidu, LinkedIn, and eBay. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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