by James Brumley | December 21, 2012 9:07 am
Admittedly, they’re tough to justify owning.
The whole point of buying a stock is to capitalize on the company’s future earnings growth … and when the stock’s current price outright dwarfs per-share earnings, one has to wonder if it’s worth it no matter how compelling the story is.
Thing is, sometimes an outrageous P/E ratio really is worth the high price of entry. Here’s a list of stunningly overvalued stocks that still somehow manage to keep rewarding investors — and will likely keep doing to going forward.
Amazon (NASDAQ:AMZN) shares haven’t traded at a P/E below 50 since 2009 and the stock’s been trading at more than 100 times earnings since mid-2011. Thanks to some heavy development spending and weaker-than-expected demand that started to really take a toll late last year, the trailing P/E ratio has now soared to more than 3,000 (3,495 at the time of this writing) with no end to the spending in sight.
Yet, there it is: Amazon shares are up more than 200% since mid-2009 when the stock’s valuation went from “rich” to “just crazy,” defying the odds as well as defying logic.
While nobody wants to pay what seems like too much for a stock, traders should also bear in mind that buying low and selling high is job No. 1 — even if that means buying a stock that feel absurdly overvalued. If the market was going to have a problem with a ridiculous valuation from Amazon, it would have had it by now.
Sometimes a quadruple-digit earnings multiple is just a temporary situation. That’s the case with World Energy Solutions (NASDAQ:XWES) anyway, which is currently priced at a trailing P/E of just under 1,100. You can thank the last quarter of 2011 for that, as the energy management company lost a shocking $781,000 (7 cents per share) on $5.9 million in sales due to weak revenue and rising expenses.
It was a one-time impasse though, and World Energy has topped estimates in the three quarter since then.
More importantly, once World Energy Solutions posts Q4-2012’s numbers and the Q4-2011 numbers finally fall off as “trailing” results, the stock should boast more relevant trailing earnings of at least 7 cents per share. Better still, 2013’s per-share income is projected at 47 cents, which translates into a forward-looking P/E of 9.4.
Yes, the organized video gaming industry is under attack in a lot of ways (not the least of which is independent game designers publishing gaming apps for tablets). The fact that THQ (NASDAQ:THQI) was forced into bankruptcy verifies that idea.
Still, the industry isn’t going away; it’s just changing … and Electronic Arts (NASDAQ:EA) is adapting to that change better than its peers. Plus, since the new gaming industry has solidified into what will likely be a more permanent and predictable reality and since THQ is in tatters, Electronic Arts is in a position to capture a little more market share.
Still, with EA shares trading at 1,425 times their trailing earnings, is there any room for upside — even in the best case scenario? Actually, yes, there is. This is a situation much like World Energy Solutions, where the trailing P/E is artificially inflated because of unusual circumstance in its recent past. On a forward-looking basis, EA is plausibly priced at 11.5 times future earnings, and that’s based on an outlook made before THQ declared bankruptcy.
At 1,420 times its trailing earnings, Peter Lynch and Warren Buffett would never be interested in buying into movie company Lions Gate Entertainment (NYSE:LGF) … not that either guru would be interested in buying into the movie business at all, regardless of the value. But in this case, there’s more to the story than some relatively obscure studio.
While most investors are still unfamiliar with the name Lions Gate, most investors are familiar with The Hunger Games — the hit movie from earlier in the year that has produced more than $686 million in box office sales. And, well, the film was distributed by Lions Gate.
There are two more books in the story’s series. The second one is already being turned into a movie and the third one is going to be split into two films. Lions Gate also owns the rights to the Twilight saga, which yielded five box office successes. In the case of Twilight, Lions Gate doesn’t pocket all those proceeds … it only pockets a small fraction of them. Still, given the dollars in play here, the company only needs to pocket a fraction of them.
Likewise, distribution rights to hit movies don’t inherently make a company profitable. But this is a great story stock … and stories can often do for a stock what actual profits can’t.
As of this writing, James Brumley did not own a position in any of the aforementioned securities.
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