Stocks with Above-Average P/E Ratios that are Worth Every Penny

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

If you're a devoted value investor, you may avoid stocks with trailing price-to-earnings ratios above that of the broader market.  However, if you're a growth investor, you might believe that the best stocks have the ability to grow earnings quickly enough to justify their valuation. In both these cases, you're in luck: The market contains some spectacular companies that you shouldn’t avoid entirely just because their P/E ratios are a bit high.

In the end, the ultimate goal of value and growth investors alike is the same:  finding spectacular companies that will provide big gains.  The following companies have great businesses, high growth rates, and fantastic balance sheets.  Furthermore, each of these companies carry valuations that may seem high on the surface, but might actually be modest compared to the valuations of their respective industries.

Google (NASDAQ: GOOG) is the $258 billion search king.  The stock trades at a trailing price-to-earnings ratio near 25.  While that might seem high, the industry's P/E ratio is 36.  The company recently reported full-year 2012 results, and the markets loved what the company had to say. 

Revenues soared more than 30% year over year, and have more than doubled since 2008.  Diluted earnings per share clocked in at $32.31 per share.  Google has a superb compound annual growth rate in earnings per share of 25% since 2008.  The company also has a spectacular financial position, with a long-term debt to equity ratio of only 11%.  Shares of Google are up more than 9% since the end of 2012.

Nike (NYSE: NKE) designs and sells apparel and accessories for men, women, and children worldwide.  The company holds a $50 billion market capitalization.  Nike currently has a trailing price-to-earnings ratio of 25, but the company holds one of the world’s most recognizable and valuable brands.  In addition, Nike's trailing P/E looks downright attractive when considering the fact that one of its closest competitors, Under Armour, holds a trailing P/E of 40. 

In January, Nike reported revenues increased more than 8% during the first six months of the year.  Nike has a stellar balance sheet with almost no long-term debt.  Nike also offers a dividend for even the most die-hard income investors, yielding 1.5% at recent prices.  Nike’s yield doesn’t surpass that of the S&P 500, but the stock offers market-beating dividend growth, having almost doubled its dividend over the last five years.

Costco (NASDAQ: COST) has had solid growth in sales and earnings since the financial crisis, and even better share price performance.  The stock has increased more than 70% since the beginning of 2010.  Costco’s net sales and net income have grown 8% and 7.7%, respectively, over the last four years, and the stock now trades at a trailing P/E ratio of almost 25.  While Costco's trailing P/E is higher than the P/E of its industry of roughly 17 times, its five-year annual growth rate in sales is almost double the growth rate of its industry, according to The Motley Fool. 

Costco has a fantastic business model, and its financial position is rock-solid, with a long-term debt to equity ratio of just 10%.  In addition, like Nike, Costco is very shareholder friendly, as the company has nearly doubled its dividend since 2008, and yields slightly more than 1%.

The Foolish Takeaway
Strict value investors probably aren’t enticed by companies whose stocks carry price-to-earnings ratios greater than 20 times.  At the same time, the three stocks on this list have demonstrated very good growth in sales and earnings over the last several years, have fantastic balance sheets, and hold some of the world’s most valuable brands.

Google, Nike, and Costco are privileged to have some of the world's most recognizable and valuable brands.  Google has provided investors stellar growth rates over the last few years, and both Google and Costco have sparkling balance sheets with almost no debt.  Nike is in a great position to capitalize on global growth and offers investors the best dividend yield of the three.  Each of these three stocks justly deserves their valuations, and prospective investors shouldn’t hold their slightly above-market P/E ratios against them.

Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale, Google, and Nike. The Motley Fool owns shares of Costco Wholesale, Google, and Nike. 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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