There are two main ways to approach selling stocks. The first is top-down analysis: the market or certain sectors look expensive, so profit-taking and portfolio rotation is required. The second is bottom-up analysis: a case-by-base analysis of company valuations.

As I wrote last week, Australian equities have solid prospects in 2018. Do not expect a wild bull market; a low double-digit total return (including dividend yield) is likely as our economy grinds a little faster.

Thus, a modest increase in portfolio exposure to Australia equities is warranted, preferably by taking profits in US or Japanese equities, if held. Fund manager warnings to sell stocks and increase cash, in anticipation of a market slump, are overdone (2019 could be a different story).

A sector approach to selling is also fraught with danger. It’s tempting to suggest selling the big miners, such as Fortescue Metals Group and BHP Billiton, after stellar gains. But with global growth improving, commodity spot prices might hold up longer than expected, leading analysts to upgrade earnings and mining-stock valuations.

The banking sector is another potential selling candidate, given its numerous regulatory, economic and social (licence) headwinds. However, lower share prices for the big banks reflect the weaker outlook. The sector is fully valued – a “hold” in broking terms.

A positive view on resource and banking stocks, 53% of the S&P/ASX 200 index by market capitalisation, supports my view on Australian equities for 2018. If banks and the big miners can notch modest gains, the market will have an OK year.

Selling stocks in 2018, therefore, is very much on a stock-by-stock rather than sector or market basis. That should always be the case. But there are times when markets or sectors become badly overvalued, demanding a more aggressive rebalancing of portfolio exposures.

At my editor’s request, I am nominating three stocks to sell in 2018. They are: Cochlear, Treasury Wine Estates and BlueScope Steel. Cochlear is an exceptional company and Treasury Wines and BlueScope have engineered two of corporate Australia’s best turnarounds. Each is included on valuation rather than quality concerns; their prices have run too far, too fast, for now.

Active investors might sell out and rotate into undervalued blue-chips (see my report last week). Long-term portfolio investors might sell part of their holding in these stocks and maintain the rest, looking to buy back in at lower prices in 2018.

Either way, it will pay to reduce exposure to these stocks, which are registering more sell calls from analysts (such recommendations are rare in broking these days) on valuation grounds.

Other stocks considered for this list include: South32, AGL Energy, CIMIC Group, Medibank Private, AusNet Services, Wesfarmers, Transurban Group, Macquarie Group and WorleyParsons.

1. Cochlear

The medical-devices star has had a cracking year, even by its standards, with a 51% total return (including dividends) over 12 months. Cochlear soared from a 52-week low of $113 to a high of $187 after posting a better-than-expected set of earnings, particularly from its US operation.

Cochlear has a strong product portfolio across its hearing implants. However, competition is rising with several rivals launching products this year. Longer term, new pharmaceutical and gene-therapies could affect device demand.

At $183, Cochlear is on a forecast price-earnings (PE) multiple of 41 times FY18 earnings, consensus earnings show. Although the well-run company deserves a significant premium given its growth prospects, the valuation leaves no room for the slightest error.

An average price target of $142, based on the consensus of 10 broking firms, suggests Cochlear is overvalued. The current share price dwarfs the highest price target of $164 and is factoring too much earnings growth for Cochlear, from market share gains, for now.

Cochlear is difficult to sell, such is its performance and quality. But every stock has its price and right now it’s too high for Cochlear.

Chart 1: Cochlear

Source: ASX

2. Treasury Wine Estates

The premium wine maker, a long-term member of the Switzer Super Report takeover portfolio, has starred with a 55% total return over 12 months. A three-year annualised return of 54% has made Treasury Wines one of the market’s top performers.

Consumers, particularly those in Asia, cannot get enough of Treasury’s premium wines. The middle-class consumption boom in Asia and rising demand for mid-priced and high-priced wines are tailwinds for Treasury, which has superbly capitalised on the opportunity.

However, competition in luxury wines is increasing, Treasury Wines does not have a compelling sustainable advantage (like most wine companies) and customer-switching costs are low. Treasury is also subject to weather, commodity and currency risks.

At $16.22, it’s hard to justify paying a forecast PE of 34 times for a business with these characteristics, even one like Treasury that has years of growth ahead from rising Chinese wine demand. The market has got ahead of itself with Treasury’s expected growth at the current price.

For perspective, Cochlear’s forecast PE of 41 reflects intellectual property that provides a sustainable competitive advantage, or “economic moat”. Treasury is selling a commodity (at least in the mid-price wines) that is harder to defend against competition.

An average price target of $14.10, based on the consensus of 10 firms, implies that Treasury Wines is overvalued at the current price.

Chart 2: Treasury Wine Estates

Source: ASX

3. BlueScope Steel

Investors who bought BlueScope when it traded at $1.53 in 2012 deserve every cent of their gains. Like other steelmakers, BlueScope was a basket case after the GFC.

BlueScope now trades at $14.06. The market latched on to BlueScope in anticipation of improving global growth, higher infrastructure spending in Australia and rising steel demand.

BlueScope is leveraged to rising Asian demand for higher valued-added steel product, such as painted and coated steel.

There’s a lot to like about BlueScope’s turnaround. Underlying earnings for FY17 (EBIT) rose 89% to $1.1 billion. Management attributed the gains to productivity and cost improvements, sales growth, improved margins on steel products and the full-year benefit of the Northern Star acquisition.

Net debt, a detractor from BlueScope for several years, fell 70% in FY17 and free cash flow is strong. BlueScope is delivering across-the-board gains.

Amid BlueScope’s price rise, it’s easy to forget that steelmaking is a less-attractive sector. The industry is highly cyclical, capital intensive and has low barriers to exit when conditions turn. Rising steelmaking capacity in China is another challenge.

Some broking firms have BlueScope trading on a forecast PE multiple of almost 20 times FY18 earnings. The steelmaking industry cannot justify that that type of multiple and BlueScope does not demand a 20% premium to the average market multiple for Australian shares.

As with Cochlear and Treasury Wines, BlueScope’s current valuation implies too much growth and leaves no margin for error.

However, an average share-price target of $13.90 from a consensus of seven broking firms suggests BlueScope is fully valued, not overvalued. The market is too optimistic.

The share-valuation broking service, Skaffold, values BlueScope at $7.20 in 2018, rising to $8.25 a year later. I’m not that bearish, but believe BlueScope warrants profit-taking at the current price with a view to reinvesting in the stock at lower prices later next year (preferably closer to $10).

Fund managers will be quick to take profits during inevitable bouts of nervousness over global growth. BlueScope’s drop mid-year highlights the potential volatility.

Chart 3: BlueScope Steel

• All prices and analysis at December 11, 2017.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.