Are These 3 Stocks Overpriced, or Is it Time to Buy?

Jason is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The market has roared to life this year and is now at all-time highs, leading many investors to fear that the search for good, cheap stocks is futile. Is value investing dead? Not likely. But just because the market’s up doesn't mean all the “expensive” stocks are bad investments.

Let’s take a look at a couple of stocks that have crushed the market over the past several years, and one that’s done well in 2013 but is still well below its all-time highs. Are these just shiny glass, or rare gems?

Cooking with gas, or up in smoke?

Chesapeake Energy (NYSE: CHK) has taken investors on a bumpy ride the past few years, and is still more than 60% off its all-time high. Mismanagement by former CEO and founder Aubrey McClendon, followed by the bottom falling out of domestic natural gas prices over the past 18 months left the company nearly crippled in debt and expenses.

However, the share price is up over 40% YTD as the company has deleveraged to a large extent, and natural gas prices have recovered from 2012’s lows. But for a company that's losing a lot of money as it continues to de-leverage, there looks to be a lot of speculation baked in to shares.

The company still carries a lot of excess debt and assets (it has targeted $4-7 billion in cash from asset sales this year.) Chesapeake has a long way to go before we see consistent profitability, and a bet on its success is a bet that natural gas demand and prices will continue to grow. There are reasons to see that as a real possibility.

Conversion to natural gas-powered trucks is picking up in the heavy-trucking sector. And when one considers that shippers consume close to 25 billion gallons of diesel annually -- about 80 times larger than Chesapeake's current equivalent output -- the opportunity could be enormous. An investor in Chesapeake would be well served to follow the earnings reports of Clean Energy Fuels and Westport Innovations. Their growth will be a clear indicator of increasing demand for natural gas as a fuel.

Any more Monster quarters?

Monster Beverage (NASDAQ: MNST) has returned shareholders a whopping 447% over the past five years, even though it’s still down about 20% from 2012’s all-time high. But with a TTM PE ratio of almost 33, there is reason for concern. Here is the pattern of growth over the recent past:

  • FY 2012: Overall growth of 21%
  • Q4 2012: Growth of 15%
  • Q1 2013: Growth of 6%, below segment average

These numbers point at shares being overpriced as growth steadily declines. Carbonated beverage sales in the US continue to slip, down by 1.2% in 2012. The only growth segment is in energy beverages, which plays to Monsters benefit; yet even that segment only grew 6.7% last year, coinciding with Monster's most recent growth rate.

Monster could be facing two very real challenges: First, as the second largest player behind privately held Red Bull, there is only so much room for Monster to take market share. Second, a competitive challenge from PepsiCo isn't out of the picture; it has massive resources to throw behind its AMP Energy drink. Coca-Cola, on the other hand, directly profits from Monster as it is the distributor in many markets.

Based on the slowed growth and the risk of competitive pressure, it looks like the best money’s been made. The valuation is awfully bubbly for a company with sales that may be going flat. 

A river of profits, or rapids ahead?

There's little doubt that Amazon (NASDAQ: AMZN) won't be selling more stuff to more people a decade from now. July 25 earnings gave investors yet another quarter of 20%+ growth, and projections for that growth to continue, and the market has clearly bought into that, with shares at all-time highs seemingly every few months. This year alone has seen shares up about 20%.

However, thin quarterly losses or at best, small profits continue to be the norm, as the company invests in expansion to support this growth. Free cash flow was down to $265 million, from $1.1 billion in the prior TTM ended June 2012. But as is often the case, we need to look at all the data: The $1.4 billion acquisition of a new corporate headquarters made a major dent in FCF. Exclude that one-time spend, and FCF is up 51% YoY. 

PE ratios are at triple digit levels; but PE may not be the best metric to value Amazon with right now, based on how the market has responded. Price/sales, at just over 2, is reasonable for Amazon, which has historically traded closer to 2.5 and higher over the past decade.

But eventually, that cash will have to hit the bottom line to support these prices. And while Amazon's growth looks like it will continue unabated, a Foolish investor would be well served to add a little over time, as by my count, over the past 12 months alone, there Amazon shares have seen a 10% or greater drop over a one month period at least four times. Jumping into Amazon at these levels could leave you up the river without a paddle. Wade in slowly, using that volatility to get better value.

Foolish wrap-up

Cheap stocks seem harder to find; but it's important to remember that the best quality gems are rarely found in the discount case. Monster may have lost its fizz, but Chesapeake and Amazon both deserve a long look from investors that are willing to ride out the volatility, and ease into their investments over time.

 

The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.


Jason Hall owns shares of Amazon.com. The Motley Fool recommends Amazon.com and Monster Beverage. The Motley Fool owns shares of Amazon.com and Monster Beverage and has the following options: long January 2014 $30 calls on Chesapeake Energy. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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