6/6/2014 1:30 PM ET|
Beware these overpriced stocks
A few of these high fliers will no doubt become the long-term success stories investors hoped for. But the odds are against you when buying such expensive fare.
Over the past few months, the market has mercilessly punished sexy, highly valued stocks. The bloodbath shows yet again that investors ignore the price of a stock at their peril.
And despite the plunge in share prices, these former high fliers are still nowhere near bargain levels.
With few exceptions, the companies that took the brunt of the shellacking are involved in either biotechnology or "new technology." Many of them only recently came public. They're generally involved in businesses everyone is talking about, everything from 3-D printing to cures for hepatitis C.
Most hit all-time highs around the end of February -- after big run-ups earlier in the month. Here's a glimpse at the damage to some of the stocks since March 6: Amazon.com (AMZN), down 13 percent; Dendreon (DNDN), -36 percent; LinkedIn (LNKD), -26 percent; Netflix (NFLX), -6 percent; Plug Power (PLUG), -34 percent; Salesforce.com (CRM), -19 percent; Shutterfly (SFLY), -24 percent; Tesla Motors (TSLA), -18 percent; and Vertex Pharmaceuticals (VRTX), -12 percent. (All returns are through June 5.)
The focus of the selling has been on story stocks -- that is, companies that lure investors, and their dollars, with good stories. A lot of that money, probably most, comes from hedge funds and other fast-trading professionals who buy stocks that are rising in the hope that their momentum will continue to push share prices skyward. Once momentum stocks reverse course, these traders make haste for the exits.
Individual investors also buy these stocks, and I fear many of them have little idea of how overpriced they are.
So let's quickly review the basics. There are dozens of different ways to value a stock. The simplest is the price-earnings ratio. Say a stock is trading at $15 a share, and analysts, on average, think it will earn $1 in the coming 12 months. The stock has a P/E of 15 -- which just happens to be the long-term average for the stock market.
- MSN Money: 10 numbers every investor should know
Now consider these high fliers' P/Es based on estimated earnings for the next 12 months: Amazon, 67; LinkedIn, 56; Netflix, 71; Salesforce.com, 72; Shutterfly, 84; Tesla Motors, 66; and Vertex Pharmaceuticals, 94. P/Es aren't available for Dendreon and Plug Power because those companies are expected to lose money over the next 12 months.
Putting this in simpler terms, paying a P/E of 50 is like spending $5,000 to buy a lemonade stand that you think will generate $100 in profits over the next 12 months. At that rate, it takes 50 years to make back your cost, assuming profits never increase.
Of course, you have to make allowances for anticipated growth. You'd expect to pay more for a company that seems likely to increase its earnings by 20 percent a year than for one that's only a 10 percent grower. That's common sense.
Where common sense turns to nonsense is when investors -- professional or amateur -- predict that a company's earnings will grow at a torrid pace -- say, 30 percent or more annually -- for five years or more. A handful of companies do end up growing that rapidly, but only a handful. Why? Mostly because of competition. If a growth opportunity is that huge, you can bet other companies will rush to cash in, too.
That's why I wouldn't touch these stocks today, even at their reduced prices. I'm not saying they won't bounce back. No one can predict short-term market moves. And a few of these companies undoubtedly will become long-term success stories. But the odds are against you when you buy such expensive fare.
What's troubling is that we've all seen this movie before. Technology stocks went through the roof in the late 1990s, then crashed in the 2000–02 bear market. Did investors -- I use the word loosely -- learn anything?
Jeremy Siegel, a longtime stock market bull, wrote a bearish piece for The Wall Street Journal in early 2000 just as tech stocks were peaking. In the article, he cautioned: "History has shown that whenever companies, no matter how great, get priced above 50 to 60 times earnings, buyer beware." Siegel is a finance professor at the University of Pennsylvania's Wharton School and a columnist for Kiplinger's. I liked his quote so much that I used it in an article published last fall warning of overpriced technology stocks.
At the same time, I wouldn't worry about the recent selloff in overpriced stocks spreading to the wider market. The excesses are as bad as they were in the late 1990s, but they're occurring in much narrower corners of the market. What's more, most reasonably priced stocks held up well during the recent tech meltdown.
Want to own tech? Consider Technology Select Sector SPDR ETF (XLK). The average P/E of the stocks in this exchange-traded fund is 16.6. The fund holds solid old-tech names such as Apple (AAPL), Microsoft (MSFT) and International Business Machines (IBM). (Microsoft owns and publishes MSN Money.) These companies aren't sexy, but neither do they trade at insane prices.
More from Kiplinger
VIDEO ON MSN MONEY
Kiplinger, Article written in 1980..
Remember your report on Silver, I'm still waiting for
it to reach a Thousand Dollars an ounce..
Even a "Broken Watch" is accurate twice a day..
Who is this author/magazine really backing? Sounds like more negativity from the failed GOP. You cannot stop this Obama Bull Market. Ride your S&P 500-based blue chips to the sky. ticker SCHD
BX Blackstone for everything else.
DOW 20,000 !!!
Copyright © 2014 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
Wall Street slows down in the summer as many traders and investors take the season off. How often are you watching your stocks?
Thanks for being one of the first people to vote. Results will be available soon. Check for results
- Every day; there's too much going on.
- Every week; can't afford to miss an opportunity.
- I've checked out for summer.
- I'm a long-term investor; summer doesn't change my schedule.