Market Close to All Time Highs: But Are There Still Buying Opportunities?

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

With the Dow Jones approaching all-time highs, it is becoming increasing difficult to find good value investments. Thus, it might be a good idea to step back and take a look at some premium selling opportunities.  But don't despair, because I also have one solid stock that can keep your money safe, yet still earn returns in the long run for those with itchy trigger fingers.

What's weighing on the market?
There is mounting speculation that the market's current rally, which started in mid-November, is overdue for a short term correction. Growing pessimism about the U.S. political situation has left many investors in the lurch. Recent revised GDP numbers have Wall Street spooked.

Finally, international problems seem to be creeping into the headlines yet again.  The mounting currency devaluations overseas can only spell decreased earnings for companies that conduct business internationally. From Asia to Europe governments are making a concerted effort to inflate their currency, at a level that makes Ben Bernanke look downright hawkish.

Better to sell good stocks than take big losses

For those lucky enough to have positions in the following two stocks, I would like to start by saying that this analysis is simply a valuation call.  I believe the following companies are great, well-run businesses with promising products.

My main thesis is that the stock price has gone too far, too fast, given the levels of growth they have seen on the books. This is often unsustainable, and can lead to one of two different outcomes.  Either the stock will become dead money for a long period while waiting for its fundamentals to catch up, or it will begin the dreaded decline into bearish territory, where speculators and traders smack the stock in every direction.

No matter how great the company, when you see a premium selling opportunity, you would be smart to at least consider whether that stock is still right for a value portfolio.

Should you put this auctioneer up for sale?

eBay (NASDAQ: EBAY) is currently trading at its highest P/E in more than five years.  I'm going to start with two visuals to illustrate my case. Looking at a three-year chart (Figure 1), we can see that a sharp upturn  began approximately one year ago.

Figure 1:

<img src="/media/images/user_14634/ebay-3-year_1_large.png" />

Since the rally started, this stock has gained almost 95%.  I bring this up for two reasons.  First, this is highly symptomatic of what is now a momentum trade.  Long-term investors need to know that these conditions often present great selling opportunities.  Consequently, when the trade ends, and the trend-line illustrated by the green line is firmly broken, history shows that things can get pretty ugly.  

The second reason is that since that time, the stock has gained over 50%, but neither revenue nor profits have kept pace with that run.  In fact, if we look at a revenue and earnings from years past (Figure 2), we can see little justification for such a sharp surge.

Figure 2:

<img src="/media/images/user_14634/growth_rateschart-ebay_large.gif" />

As I said earlier, I believe that eBay is a great company.  However, with the introduction of momentum traders, revenue that's not keeping pace with price, and the stock trading at five-year historic P/E highs, it might be wise to consider taking some profits.

Should you pour this beer down the drain?
Another great company that I'm sad to see put on this list is Boston Beer (NYSE: SAM).  Though Boston Beer has seen a great run lately (Figure 3), its rise wasn't due to fundamentals, momentum traders, or earth-shattering news.

Figure 3:

<img src="/media/images/user_14634/sam-1-year_large.png" />

This was a good old fashioned short squeeze that caught many off guard, resulting in a spike of 40%.  Since spikes of this nature are due to a temporary trading condition (in this case, an overcrowded short trade that backfired), it is always wise to consider taking profits.

This short squeeze has also left Boston Beer with some highly questionable valuations.  I've listed them in the following table (Figure 4) to convince you.

Figure 4:

<table> <tbody> <tr> <td>Valuation</td> <td>The Boston Beer Company</td> </tr> <tr> <td>P/E</td> <td>35.50</td> </tr> <tr> <td>Price/Sales</td> <td>3.19</td> </tr> <tr> <td>Price/Book</td> <td>8.19</td> </tr> </tbody> </table>

Just a quick look at the most basic numbers leads me to believe that this stock is highly overvalued.  Even on a forward-looking basis, this is still very expensive at a 29 forward P/E.  Also, looking at just the most recent year, the stock has seen a 60% gain, while revenue is only growing by 7% year over year.  Even if margins improve drastically, there is no way this kind of move to the upside is sustainable, given its fundamentals.

Once again, this is a fantastic company with a great product.  But just as value investors seek  inexpensive stocks, we must also discard expensive stocks when the opportunity arises.

Enough selling --  let's buy something

One of my favorite stocks over the last few years has been Walt Disney (NYSE: DIS), because of its unique nature, smart management, solid growth, and firm dedication to future returns.  Disney isn't just about a cartoon mouse and animated movies.  It's a global media powerhouse that owns television networks ABC and ESPN.  Recently, it went on a spending spree to acquire Pixar (2006), Marvel (2009), and Lucasfilm (2012), making Disney the undisputed king of fantasy.

While Disney's stock has seen quite a run lately, up 35% in the last year alone, there still appears to be room to the upside.  This is due to recent earnings out-pacing the historic averages.  The average five-year EPS growth rate is 8.05%, while the average three-year is a whopping 19.58%.  The most recent year booked 18.20% EPS growth rate.

A close look at several metrics (Figure 5) shows that Disney has been outperforming compared with historic averages, particularly in growth and profitability.  This is quite an accomplishment given Disney's increasing size.

Figure 5:

<table> <tbody> <tr> <td><strong>Metric</strong></td> <td><strong>Five-Year Avg. <br /></strong></td> <td><strong>Most Recent Year <br /></strong></td> </tr> <tr> <td>Sales Growth</td> <td>3.04%</td> <td>5.20%</td> </tr> <tr> <td>Net Profit Growth</td> <td>11.40%</td> <td>13.20%</td> </tr> <tr> <td>Return on Assets</td> <td>6.50%</td> <td>7.00%</td> </tr> <tr> <td>Yield</td> <td>1.20%</td> <td>1.40%</td> </tr> </tbody> </table>

A quick note on Disney's current yield of 1.40%: With a low payout ratio of 22%, and a renewed dedication to returning money to shareholders, this dividend will almost certainly increase.  In fact, over the last two years, we have seen the dividend rise from $0.40/share in 2010, up 50% to $0.60/share in 2011.  Finally in 2012 the dividend was increased another 25% to $0.75/share.  Look for this to continue over the foreseeable future.

Selling at an attractive P/E of only 17, Disney represents a unique company with a solid future.  Looking ahead, I'm expecting Disney to earn $3.90 for FY 2014.  Applying a more realistic P/E of 18 gives a price target of $70.  That's nearly another 30% increase over current prices.

In conclusion...
While it may be difficult to sell a great stock that has provided some fantastic returns, sometimes it must be done. If the same valuations that once told you to purchase a stock are now telling you to sell, you would be wise to at least consider this option.

Trailing stops are often useful in situations where you believe the run could continue, but want to protect your profits.  I highly encourage those in such scenarios.  But don't despair, because there are always opportunities for the very astute stock picker.  Sometimes, the pain of selling a winning position can be mitigated by the excitement of a new investment with better potential.


Lulupoopsalot has no position in any stocks mentioned. The Motley Fool recommends Boston Beer, eBay, and Walt Disney. The Motley Fool owns shares of Boston Beer, eBay, and Walt Disney. 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!

blog comments powered by Disqus