Morningstar Says Sell These 3 — I Checked, and the Real Risk Is Hidden

TL;DR I ran the three stocks Morningstar flagged as sells — Applied Materials, Teradyne, and American Airlines — through my own process. All three look good on the surface, but the first two carry semiconductor-cycle peak risk and the last carries debt it can't handle. A good company bought at the wrong price is a bad investment.

A Good Company Is Not the Same as a Good Investment

Let me start with one of my core rules: a great company bought at the wrong price becomes a bad investment. The three stocks Morningstar's strategist flagged as sells test exactly this rule. Why sell companies whose businesses are booming right now? I took each one apart with the numbers.

1. Applied Materials (AMAT): Peak-of-the-Boom Risk

Here's the core — the business is booming, and that itself is the warning sign.

Applied Materials makes the machines that make chips — the picks and shovels of the entire chip industry. With the whole world building AI chips at once, this company is making a fortune. The catch: this has historically been a brutal boom-and-bust business. When everyone rushes to build chips, AMAT rakes it in; when construction slows, orders dry up fast and the stock falls hard.

The numbers: $427 billion market cap, $434 billion enterprise value — just $8 billion of net debt. Free cash flow of $6 billion. The balance sheet is fine. The problem is valuation: about 71x free cash flow and 50x earnings. That's a big number. Margins are improving — 24% over ten years, 26% over five, nearly 30% last year — and returns on capital are high.

But here's what confuses me: revenue growth was only 3% a year over the last three years. If this is a boom, why only 3%? Maybe that strategist is onto something.

My 10-year assumptions — revenue growth 3, 5, 7%; margins 20, 23, 26%; PE 15, 18, 21; 9% return. The result at today's $538: low $110, high $240, middle $166. If the middle case is right, buying today locks in a -5% annual return. You can see why Michael Burry is short this name.

2. Teradyne (TER): Same Cycle, Different Name

Teradyne is the mirror image of Applied Materials.

Teradyne makes the equipment that tests whether chips actually work, and it also builds factory robots. Catching the theme? This too is a cyclical business tied to how many chips the world makes. When the chip cycle cools, demand for testing gear cools right with it.

Market cap $60 billion with roughly the same enterprise value. Free cash flow sits below net income, because capex jumped from $13 million to $225 million over five years. It trades at 108x free cash flow. Margins run 20% (ten-year), 21.5% (five-year), 22.5% (one-year), with a 59% gross margin — decent, but not Google or Palantir territory.

Same question here — revenue grew just 7.9% over three years and 3.5% over five. Surprisingly weak during the exact three years of the AI-and-chip boom. Yet analysts see EPS doubling from $7.31 to $14.86 over four years and revenue rising from $4.5 billion to $7.7 billion. Weak growth in the past, but a boom ahead? I put a question mark there.

One fun calculation: multiply the final-year EPS by a 22x PE and you get roughly a $330 company. The current price? $330. Even if the analysts are right, you're already paying it. My assumptions (revenue 3, 6, 9%; margins 17, 19, 21%; PE 14, 17, 20) give a low of $60, high of $145, middle of $95 — a -6% annual return.

3. American Airlines (AAL): The Problem Isn't the Numbers, It's the Debt

This one is the clearest of the three — I avoid it purely because of the debt.

Airlines are a brutally hard business, as Warren Buffett has pointed out again and again. They cost a fortune to run, they get hammered by fuel prices, and most carry mountains of debt. American Airlines carries one of the heaviest debt loads in the entire industry.

The numbers almost make me laugh. Market cap $11.5 billion, but enterprise value $72 billion — $61 billion of net debt. Free cash flow was -$1.8 billion last year, with a five-year average of just $57 million. Low returns on capital, high debt, and margins that were negative across the last decade and barely positive over five years.

Pre-COVID, they did $45 billion of revenue for $1.3–1.7 billion of profit — a 3–4% margin. On today's revenue and margin, maybe $2 billion of profit is possible, roughly 5x the market cap. But the debt lurking behind it is the problem. I once bought Walgreens without paying attention to its debt levels — they were astronomical, and I got lucky selling early. American Airlines gives me the exact same feeling. The moment rates jump and they have to refinance, this debt can bury the company. Layer on oil-spike risk from the Iran conflict, and it's ugly.

Interestingly, running the stock analyzer (revenue 1, 3, 5%; margins 1, 2, 3%; PE 12, 15, 18) spits out a middle value of $26 and a 15% return — a green light against today's $17. But I don't trust that green light. This is exactly where the tool can mislead you: debt and industry structure hide behind the numbers.

What These Three Teach Us

The first two are about the cycle; the last is about debt. The common thread is that strong surface results mask the real risk.

I largely agree with Morningstar's sell calls here. The bigger lesson: a tool like a stock analyzer can flash green on a debt-laden airline. Don't just read the numbers — read the story they're telling. Among airlines I only own Southwest, because apart from the single COVID year it has been profitable every year across roughly 50 years as a public company. Even so, my biggest worry is still the simple fact that it's an airline.