Some stocks are expensive for a reason. Others are ridiculously expensive.
Knowing the difference is one of the keys to successful investing in today’s fast-moving markets.
The prize for the most ridiculously expensive stock so far this year goes to GameStop Corp. (GME), which at one point reached a high of US$483 in intraday trading on Jan. 28.
There was no rational reason to support this valuation. GameStop is a money-losing company with trailing 12-month earnings of a loss of US$4.33 a share. There is no reason to believe it will be profitable any time in the foreseeable future.
The price rise was fed purely by social-media hype, specifically the Reddit mob who are part of the WallStreetBets forum. Those who got in early and sold near the peak made big bucks.
But those who bought near the top were whipsawed like the Wall Street hedge funds who were the original targets of this couch-potato revolt. After another several days of volatility, GameStop closed Monday at US$60, down 87.5 per cent from its Jan. 28 high. Even that price is too high, based on the fundamentals.
Meantime, two companies that are expensive with a reason reported impressive results last week.
Amazon.com Inc. (AMZN) reported record quarterly sales of US$125.6-billion, compared with US$87.4-billion in the same period of 2019. It was the first time the company has topped the US$100-billion sales mark in a single quarter. Net income increased to US$7.2-billion (US$14.09 a diluted share), compared with US$3.3-billion, (US$6.47) in the fourth quarter of 2019. Free cash flow increased to US$31-billion for the trailing 12 months, compared with US$25.8-billion for the period ended Dec. 31, 2019.
For the full fiscal year, net sales increased 38 per cent to US$386.1-billion, compared with US$280.5-billion in 2019. Net income came in at US$21.3-billion (US$41.83 a share), compared with US$11.6-billion (US$23.01) in 2019.
Impressive numbers, any way you read them.
“Amazon is what it is because of invention,” said founder Jeff Bezos, who is relinquishing the CEO role in the third quarter but will remain as executive chair. “We do crazy things together and then make them normal,” he said in an e-mail last week to employees. “We pioneered customer reviews, 1-Click, personalized recommendations, Prime’s insanely fast shipping, Just Walk Out shopping, the Climate Pledge, Kindle, Alexa, marketplace, infrastructure cloud computing, Career Choice, and much more,” he said.
“Right now, I see Amazon at its most inventive ever, making it an optimal time for this transition.”
Andy Jassy, CEO of Amazon Web Services, will take over from Mr. Bezos to head the company.
When I first recommended Amazon in my Internet Wealth Builder newsletter in January, 2017, I wrote that the stock was expensive, with an extremely high price-to-earnings ratio of 92.4. But I suggested that it would be even more pricey a year down the road. At the time, it was trading at US$817.14. It closed Monday at US$3,322.94, up 306.6 per cent from the original recommendation. The current P/E is 79. The stock is still very expensive, but for a reason. I continue to believe it will be even more costly next year.
Another stock that is expensive for a reason is Alphabet Inc. (GOOGL), the parent company of Google. It too announced results last week and, like Amazon, it blew past analysts’ estimates.
The company reported record revenue of US$56.9-billion in the fourth quarter, up 24 per cent from US$46.1-billion in the same period of 2019. Net income was US$15.2-billion (US$22.30 a share) compared with US$10.7-billion (US$15.35) the year before.
For fiscal 2020, Alphabet reported revenue of US$182.5-billion, up from US$161.9-billion in 2019. Earnings were US$40.3-billion (US$58.61 a share, fully diluted), up from US$34.3-billion (US$49.16) the year before.
The company’s strong performance was based mainly on strong advertising revenue from its search function and YouTube. Cloud revenue, which the company broke out for the first time, showed a fourth-quarter gain of 47 per cent to US$3.8-billion but the segment still operated at a loss of US$1.2-billion. The company’s “Other Bets” segment, which dabbles in far-out ideas, showed revenue of US$196-million in the fourth quarter, with a loss of US$1.1-billion.
Alphabet’s stock rose about 8 per cent on Feb. 3, the day after the results came out. The shares closed Monday at US$2,084.52. We recommended it in my newsletter in March, 2014, at US$607.40 (split-adjusted). The trailing 12-month P/E is 35.6, much lower than that of Amazon but still expensive. Here again, I expect the price will be even more costly a year from now.
As both Amazon and Alphabet prove, buying expensive stocks for the right reasons can be very profitable. Both companies will experience temporary setbacks over time – that’s normal. But I expect the overall upward trend to continue to move higher in the years to come.
Full disclosure: The author personally owns shares in Alphabet.
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