Is This the End of the High-Priced P/E?
Oct 28th 2011 9:35AM
Updated Oct 28th 2011 9:54AM
Optimists beware -- another one of your safe havens appears to be compromised.
I feel it would be too early in the earnings season to claim this is the death of the high-priced P/E, but so far all signs are pointing to its untimely demise. In just a matter of days we've seen Netflix (NAS: NFLX) forecast greater-than-anticipated subscriber losses, while last night Amazon.com (NAS: AMZN) , a favorite of mine, missed profit projections by a mile as margins slumped.
Prior to these earnings reports, things were more or less fine with these two companies from a financial perspective, albeit they were trading at P/E ratios north of 100 for Amazon and 30 for Netflix -- but, the tide appears to be changing.
From an investor's perspective, macroeconomic worries are supplanting years of strong performance, and we're discovering it doesn't take much for these highfliers to fall off the valuation cliff. Mounting worries regarding the house of cards that Greece has built in Europe, coupled with slowing growth in China and the U.S., has investors concerned. This concern came to fruition yesterday when consumer sentiment figures showed the greatest amount of investor pessimism we've witnessed in two-and-a-half years. To add, volatility remains extraordinarily high despite coming significantly off its recent highs signaling investors' unwillingness to take risks.
It remains to be seen if other pricey companies are soon to follow the path that Netflix and Amazon have laid, but if I were invested in any of the following five companies, I'd strongly recommend reconsidering my investment thesis this earnings season.
OpenTable (NAS: OPEN)
Here's a company that aptly "fits the bill" as a poster child for excess. Growth has not been an issue for this online reservation facilitator as the company booked a 53% jump in revenue last quarter and notched yet another earnings beat. Unfortunately, at 64 times trailing earnings, traders may have finally had enough with OpenTable. A myriad of macroeconomic concerns -- including a slowdown in U.S. growth and the rising price of food -- has many, including myself, wondering how OpenTable will keep up its torrid growth pace. Add to this that Google may be marking its territory in the reservation business with its purchase of Zagat last month and you have a potential recipe for food poisoning.
salesforce.com (NYS: CRM)
As cliche as it sounds, salesforce.com has its head in the clouds, and if it's not careful lightning (i.e., short-sellers) may strike down upon it with great vengeance and furious anger. The cloud-based software company hasn't had any trouble impressing investors with its revenue growth as its 38% jump last quarter would indicate. The concern I have relates to the company's frivolous spending habits. Whereas Microsoft focuses on larger clients for its Dynamics suite, salesforce.com spends about half of its revenue on attracting new customers. Clearly, expanding the business is important, but it's this same overexpansion that got Netflix in trouble with investors this quarter. The trailing-12-month earnings multiple on salesforce.com is well in excess of 600, and I feel it could be set up to rain red this earnings season.
Baidu (NAS: BIDU)
Perhaps the only company that has been immune to the talk of Chinese accounting scandals, Baidu has been a technology staple in many investors' portfolios for years -- and for good reason. It's difficult to argue against a company that can double its revenue in just two years. Unfortunately for Baidu, the steps the Chinese government has been taking to cool off its economy are finally setting in, and it could become a casualty to the country's slowing growth. Although Baidu maintains 70% of the search engine market share now, Microsoft and Sohu.com are waiting in the wings to chip away at its dominance. At 26 times book value, 28 times sales, and 58 times trailing-12-month earnings, even the slightest hint of weakness will be cause for a sell-off.
Blue Nile (NAS: NILE)
Make no mistake about it, this isn't the first time I've chosen to be bearish on Blue Nile. As I noted in May, the one advantage Blue Nile has over its brick-and-mortar competitors is its low overhead costs. But, as I also noticed, it appeared Blue Nile was losing its comparative advantage in diamond pricing. Because the online jewelry retailer only purchases a very small selection of diamonds for its stock, it has had to significantly raise its prices to account for rapidly rising labor and diamonds costs worldwide - negating any advantage it had over bricks-and-mortar retailers in the first place. With consumer sentiment at near-term lows, it's very difficult to get behind a luxury retailer trading at 49 times trailing-12-month earnings and 13 times book value in the first place. I'd once again say no to this proposal.
LinkedIn (NYS: LNKD)
Relax Pandora shareholders, I'm not going to pick on your stock -- then again you needed to at least be profitable to make this list. LinkedIn qualifies ... barely. The online social networking company is growing rapidly as evidenced by the 61% jump in its membership during the second quarter, but it's hard to see ad revenue supporting the company's current valuation. Plus, investing in the social media sector is tricky. Groupon's IPO is now expected to be valued at only half of the $25 billion it was projected to just a few months ago, proving just how fickle consumers can be. Valued at 485 times trailing-12-month earnings, it may earn the right to be called the most overvalued publicly traded company.
So what's an investor to do?
Ideally, you should be re-examining your investment thesis on your holdings regularly. If the reasons you purchased a stock in the first place are still valid, then there's no need to change your investment thesis. However, if the vultures have begun to circle your stock, ask yourself what reason(s) pessimists might have for sending your stock lower. If the risks outweigh the rewards or you can no longer support your original investment thesis, it's time to sell.
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At the time this article was published The Motley Fool owns shares of Microsoft and Google. Motley Fool newsletter services have recommended buying shares of Netflix, Amazon.com, Baidu, Sohu.com, OpenTable, salesforce.com, Blue Nile, Google, and Microsoft, as well as creating a bull call spread position in Microsoft and in a separate newsletter shorting shares of salesforce.com.Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He doesn't like heights so you probably won't catch him near any cliffs anytime soon. You can follow him on CAPS under the screen name TMFUltraLong and on Twitter where he goes by the handle @TMFUltraLong. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy which is large and in charge.
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