TheStreet.com Ratings provides exclusive stock, ETF and mutual fund ratings and commentary based on award-winning, proprietary tools. Its "safety first" approach to investing aims to reduce risk while seeking total return performance. BOSTON ( TheStreet) -- Yesterday's stock-market drop, the worst in seven weeks, shows investors' wishful thinking crumbles when reality hits. Perhaps the worst bets are overpriced popular companies. Here are three with glaring flaws. At $81, Amazon ( AMZN - Get Report) is overpriced. A discounter trading at an outsized premium is a contradiction. The shares are selling at a 2009 price-to-earnings ratio of 48 and a 2010 P/E of 37. And the stock has already climbed 58% in 2009, outpacing all major indices. Although Amazon has dropped from its annual high of $93.87, it may fall further. The Kindle II e-reader is a revolutionary product, and I am impressed by Amazon's courageous entry into consumer electronics. But analysts have a grasp on product sales and Apple ( AAPL - Get Report) isn't going to let the e-book market go uncontested. Apple's Tablet is expected to debut within a year. Amazon will endure heavy competition if Apple launches an iTunes book store. And although its ventures into cloud computing and e-commerce consulting paved important growth avenues, they have done nothing to improve the company's thin margins.
Amazon's second-quarter operating margin fell from 4.5% to 4% and the net margin shrank from 3.9% to 3.1%, as the company scooped up around $142 million of quarterly profits, a 10% drop from a year earlier. The company's bread-and-butter North America media revenue remained flat. A report released last Thursday by NPD showed that U.S. video-game sales fell 29% in July, a sign that consumer retrenchment is an ongoing and underestimated market force. Video game-related sales make up a sizable chunk of Amazon's media revenue.
Amazon is the best-in-class Internet retailer, but right now it's far too expensive, with overly optimistic expectations embedded in its share price. I recommend avoiding this stock until it's closer to $75. If you're interested in buying a piece of the Web, look at China-based NetEase.com ( NASDAQ). Whole Foods ( WFMI) is another stock that should be included in your watch list, but not your portfolio. The shares have surged 185% in 2009 and are up 37% over a one-year period when the Dow lost 22% and the S&P 500 dropped 24%. The stock trades at a 2009 price-to-earnings ratio of 31 and a 2010 P/E of 25. July job losses beat the consensus, but I can assure you that the unemployment line isn't snacking on seven-grain crackers and baked brie. Whole Foods has made notable improvements to its balance sheet since the year-earlier quarter. The cash balance has multiplied to $448 million, equating to an adequate quick ratio of 0.9, and the debt-to-equity ratio has descended to 0.4, demonstrating restrained leverage. Comparable-store sales, a key gauge of top-line performance, were down 2.5% during the latest quarter and identical-store sales, which exclude relocations and expansions, fell a telling 3.8%. But revenue eked out a 2% gain to $1.9 billion. And gross, operating and net margins showed marginal improvement. Although Whole Foods is undervalued on the basis of sales and book value, the stock is 58% more expensive than food-retail peers when examining 2009 earnings estimates. And it's 45% more expensive than rivals when considering 2010 profit expectations.
The argument that Whole Foods is now a "regular" supermarket doesn't explain why its stock is so expensive. Large-cap competitors Kroger ( KR) and Safeway ( SWY) trade at 2009 price-to-earnings ratios under 11 and haven't enjoyed any blistering rally. Like Amazon, Whole Foods is a great company to own at the right price. But don't take out a second mortgage to buy the shares. Management notes in the quarterly press release that average weekly sales typically decline in the fiscal fourth quarter, resulting in lower gross profit, and the company expects higher general and administrative expenses. The put/call open interest ratio is heavily bearish and at an annual peak, indicating that options traders are betting on a serious pullback. Freeport McMoRan ( FCX - Get Report) became a market darling this year. Its shares are up 144% and a remarkable 125% since March. Admittedly, investors exaggerated the decline of metals demand in 2008, but this newfound optimism requires temperance. Despite impressive market outperformance, Freeport is still enduring a difficult operating environment. Second-quarter net income dropped 36% to $648 million as revenue declined 32% to $3.7 billion. Freeport is the world's second-largest copper supplier, giving it exposure to the burgeoning Chinese economy. But share-buying has turned speculative. At a 2009 price-to-earnings ratio of 23, Freeport isn't terribly expensive, but it's volatile. The stock has a beta, a measure of market correlation, of 1.9. During Friday's sell-off, Freeport dropped 4%, more than large-cap mining peers Rio Tinto ( RTP) and Newmont ( NEM - Get Report) and far more than major indices. The market has become enamored of certain ideas, like emerging markets' insatiable appetite for metals and materials.
I fear that Freeport is due for a serious pullback if a correction occurs. We rate Freeport "sell" due to its weak fundamentals. Our model gives the company a financial strength score of just 3.5 out of 10. The outlook for copper prices, which have surged in 2009 on signs of a Chinese recovery, is becoming increasingly negative. The metal is at a 10-month high. The U.S. is the second-biggest consumer of copper and our auto and home-building industries, despite improvement, are still weak. The latest data from the London Metals Exchange showed that copper reserves are on the rise. -- Reported by Jake Lynch in Boston.