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
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 (
. 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
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
readers of, called "Obermueller's Law": The market is always trying
to tell you something. And that is the
with the P/E ratio: It is a measure of investor expectations, and
those expectations are evident in its deviation from the
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
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
has a P/E ratio of 1238, according to
. 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
for their reflection of social media enthusiasm, but I would not
The real-estate players
are in the real-estate listings business, Zillow for residential
properties, LoopNet for commercial.
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
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,
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
P.S. -- And that's not all there is. We'd like to share some of
our most unique -- and potentially lucrative -- investment ideas
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2012." This report lays out the details of all our predictions for
the coming 12 months -- and the stocks that will profit from these
Andy Obermueller does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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