Saturday, July 26, 2014

Comparing Stock Valuations: an example

Yesterday I wrote about my confidence in MCD's long term business prospects.  I compared the fast food giant’s brand and public perception to the fast growing, hip Chipotle.  I received feedback suggesting I consider the difference in the companies’ valuations.  The fact that MCD’s PE (15) is much lower than CMG’s (57) is of course very logical given CMG’s current growth rate and the potential for significant long term growth.

The notion that CMG is “expensive” brings to mind a recent analysis I’ve heard regarding another rapidly growing company, Facebook (FB).  Everybody’s favorite social network is growing 60% annually.  Analyses assuming companies like CMG and FB will continue to grow at such rapid clips certainly justify the higher PE’s.  On paper.

But as I glance up at CNBC’s list of “losers” from Thursday (Staples, SPLS; Amazon, AMZN), I am reminded of the reason I usually decide to pass on mega-growth stocks with very high multiples.  Companies that are priced for near perfect results can trade solely on market sentiment.  In these stocks, the fundamentals of the business are often ignored after the company fails to meet the street’s high expectations.  That is why I believe AAPL could be purchased for 9 times earnings in not too long ago.  Despite its dominant position and great prospects, investors dumped the stock because of Steve Jobs’ death, or a lack of “new” products, or some other reason.

Buying shares of great companies at bargain valuations and having an “I don’t buy the pricey stuff” rule makes sense to me.

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