These Are Some of the Most Expensive Stocks I've Ever Seen...
The stock market is a game of expectations. And one of the best ways of gauging investor expectation is by looking at a stock's price-to-earnings ratio, or P/E for short.
As readers of my Game-Changing Stocks newsletter know, I like to turn conventional thinking on its head. So while most investors like to look for stocks with low P/E ratios, ostensibly to find a "cheap" stock, I recently decided to look at companies that have high P/Es. My thinking behind this is that I just might find a stock with high expectations that are warranted and could outperform.
First, a bit about P/E ratios... It's calculated by dividing a company's stock price by its earnings per share (EPS). The P/E is best used to compare industry peers: If two companies operate in the same business yet have different valuations, one rightly ought to wonder why.
From a wider perspective, the P/E also can be used to ascertain general investor sentiment: If the market is trading at an earnings multiple that's lower than its historical average, then investors have lost some degree of faith in companies' ability to deliver future earnings. When the market's P/E rises above its norms, one can conclude that investors are expecting greater results than they have seen in the past.
This harkens back to something I always remind Game-Changing Stocks readers of, called "Obermueller's Law": The market is always trying to tell you something. And that is the bottom line with the P/E ratio: It is a measure of investor expectations, and those expectations are evident in its deviation from the mean.
So what companies are selling at a substantial premium to earnings? After all, investors must clearly expect a lot from companies with extraordinarily high P/Es. Perhaps they're on to something. The question going forward is whether these stocks will continue to rise with -- and even outperform -- the broader market, or whether they're wrong and you should short the stock.
It's with this in mind that I went looking for stocks with a P/E ratio above 50. I cut out companies with dividends of more than 2% in this screen because sometimes unique securities such as trusts have high P/E ratios, yet they don't quite fit our purposes for this screen. Companies that have not recently shown a profit didn't make the list either.
Also note that I used the Bloomberg Professional Service for this screen, and the P/Es I quote might not match up with what you might get from another source. There are a lot of stock screeners out there, but I use this one because I consider the data all but infallible.
Here are a few of notables from among the 321 companies I found with a P/E of greater than 50...
Avoid this overhyped stock
Online resume and social networking site LinkedIn (Nasdaq: LNKD) has a P/E ratio of 1238, according to Bloomberg. The $9.8 billion company has basically doubled revenue for the past four years. It also needs to double earnings for five more years, from $0.12 per share to $3.84, just to be "fairly" valued with the broader market at about 22 times earnings. Unfortunately, every penny of those gains is already priced in, so there's really no immediate upside. I'd note these shares for their reflection of social media enthusiasm, but I would not buy them.
LoopNet -- now selling for 123.7 times earnings -- has seen revenue stay flat for the past four years, while earnings per share have fallen from $0.49 to $0.04. If this company were to produce the results it has already proven capable of and return to the $0.49 earnings per share range, then its P/E would fall to 37. That's still rich, but hardly off the charts and likely is indicative of this website's ability to generate results. I just see some really big "ifs" in all this -- earnings have been trending in wrong direction, which is a bad sign when the top line is flat.
That leaves Zillow, which commands 480.8 times earnings. The company has shown a remarkable track record of growth, increasing revenue 523% since the end of 2008. The thing is, the company has just become profitable, earning about $1 million on $66.1 million in annual revenue. Three things are likely going to happen: 1) The company will continue to grow revenue as the real-estate market improves with the broader economy, 2) Margin will improve as the company finds its footing and 3) These factors will combine to force the P/E to a more reasonable level, but the share price is likely to rise.
This company is likely worth 40 times earnings for the next two years. If it can, in that time, increase margins to 20% and maintain its top-line growth rate, then that brings revenue to $250 million a year, earnings to $50 million, and at 40 times earnings, raises its market cap to $2 billion, a 118% gain from its current levels.
Risks to Consider: Sometimes stocks have high P/Es for a reason -- they're overbought. You should do your own research to find out if the exuberance behind a stock is justified or if it's irrational. In the case of the latter, you may find it's even worth shorting.
Action to Take --> Zillow is the leader among the companies that turned up on my screen. It's a good intermediate-term play for aggressive growth investors.