Five Great Quality Companies: Are They Too Expensive?

by: Larry Bellehumeur July 28, 2008 | about stocks: AAPL / GOOG / MA / MON / RIMM    

Larry Bellehumeur

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I'm the first one to like to pay for value.....I like the extra thick hardwood floors that my wife and I had installed. They cost more, but they give a great feel and add value to the house. Same for the fact that I spent more for my Mercedes than for a lesser priced car, as I see the value in quality.

However, at what point does "quality" just become too expensive?

These 5 companies are great companies, but is a great company still great when it is overly expensive? It is, but it makes it a bad stock …All of these stocks are worth buying at better evaluations….

1) Monsanto (MON)

Yes, this truly is a great company, and agriculture is a great place to be. So what is the problem? For one, the company is trading at 33x expected 2008 earnings, and about 26x 2009 projected earnings, in what is supposed to be a down market. This price means that this one can't disappoint at all, or else it will see some serious multiple contraction.

With an expected growth rate of 28% (that does seem high to me, so I would likely lower it down to 22x 2008 earnings to provide more of a margin of safety -- yes, I've been to Omaha, and drank Buffett's Kool-Aid), this means that a more suitable price may be in the $75 to $80 range, a far drop from its current price north of $115.

(FYI – I'm sure to see comments on this one, which I welcome. I know Monsanto well, as I have done some work with both this company and one of its main competitors, Syngenta. Syngenta (SYN) trades at a more reasonable 19x 2008 earnings, by the way)

2) Google (GOOG)

First off, I love Google. I used many of its products all of the time, and think that it has a world-class brand. It likely will do well in all areas that it ventures into.

My love ends when I try to get my head around the evaluation of its stock. Most of its revenue still comes in the form of search and its various ways to get revenue (ad-clicking, search order placement, etc). Last time I checked, everyone else who is tied to the consumer has seen their stock severely trounced. While Google has corrected from its ridiculous high of over $745 last fall, it still trades at 29x 2008 earnings.

The market is calling for a 20-25% earnings growth from Google (which I think might still be on the high side, considering the environment that we are in). I suspect that we'll see earnings revisions falling if the economy does not turn around a bit faster. I still like Google better than most of the S&P, so I don't mind giving it an evaluation higher than most.

With a 20x 2008 earnings multiple, and an expected earnings of $16.25 in 2008, I would peg Google's value at a more trim $325US (which is well short of its price of close to $500US now).

3) Apple (AAPL)

With all due respect to Steve Jobs, whom in my humble opinion, is the premier CEO in all of business, this one smells expensive. Sure, the company is firing on all cylinders - iPods are still all the rage, everyone wants a new 3G iPhone, and Mac has really started to heat up its marketshare against Microsoft (MSFT). So, how can such a company with these growth characteristics be overvalued?

First, its recent low guidance doesn't scare me. It always guides low, so why should it change now? What scares me is the fact that this stock is now priced as if there is little chance that anything can derail its success. While Apple is brilliant in its ability to remember that consumers buy electronics as consumers and not as engineers (so, coolness helps). However, consumers are notoriously fickle (anyone still own Crocs (CROX) stock?). While it has a great brand name, and a great pulse on the consumer, is this enough of a sustainable competitive advantage to justify its evaluation? Also, while everyone seems to find money for Apple's toys, regardless of the state of the economy, I suspect that things might be a bit worse before they get better, so even toys such as iPods become discretionary at some point.

Like Google, I would still recommend giving Apple a superior evaluation to the overall S&P. I'd even be willing to give it a higher P/E than Google, so I would say 22x 2008 earnings is fair. This would give the company a fair value of $114. Apple did get down to close to that price, so I did buy Apple at $120 or so earlier this year, but I sold it at $180 a while back.

4) Mastercard (MA)

Mastercard is the kind of stock that you can buy and hold until your retirement, regardless of how old you are….yes, it is that good. It has great exposure to many key areas. First, it is a great way to play to strong movement away from cash to credit. Second, it has a network that would be quite hard to develop from scratch, and its main competitors (Visa (V) and AmEx (AXP)) are all growing well. Finally, it provides strong exposure to International markets. And, to boot, it has no exposure to credit losses (see Amex), as those are handled by the banks.

So, why does it make this list? Everyone believes that the consumer is hurting right now, and many large purchases get put off. When it costs more to put gas in your tank and to buy groceries, discretionary spending gets hit. While people still may use their M/C for gas and food, more people use it for clothes, household items, etc, and these may see a dip in the next year or so.

At 29x 2008 earnings, this one isn't factoring in the consumer spending slowdown. Again, buy MA for the long run, just not at these prices. I would think that it warrants an Apple-like P/E, based on its merits. Using a 22x 2008 earnings ratio, this one should trade more in the $195 range (down from its north of $250 price now).

5) Research in Motion (RIMM)

Being that this is a great Canadian success story, and that I am a proud Canuck, this one is painful for me to add. This one has always seemed overvalued, but has been an absolute gem of a performer over the past few years. Does anyone not know the Blackberry brand? Is there anyone at the airport not typing on one? RIM is an absolute dominant player in this space, and does have a great moat around its business (ok, last Buffett term, I promise). However, that is where the praise ends.

RIM is a very volatile name, as people seem to always want to find a reason to chop its P/E down. Whether it is a threat from Apple, patent challenges or exposure to the Financial sector, everyone has a reason from RIM to fall.

Whlle I think that all of those things are well known, they aren't reasons not to buy RIM. Its evaluation may be, though. At 31x Feburary 2009 earnings, this one is priced for perfection. I think that there will be some weakness in the economy, and even RIM won't be able to escape it. This one is a great long-term hold, though, so look for it at a lower price.

I would give RIM a rich 24x current year evaluation, my highest of the five. Based on an expected earnings of $3.65 (I'm knocking it down from the consensus), it would be a screaming buy when it is south of $90.

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This article has 32 comments:

  •  
    Jul 28 08:07 AM
    There is something to be said for anything that is growing rapidly in these ever inflationary times and those 5 names appear safe bets in the short term having already reported. At some point a more realistic approach to value investing will find them at prices worth jumping back in - but not here.
    Reply | Link to Comment
  •  
    Jul 28 08:30 AM
    Your analysis of Apple is extremely flawed on a number of levels. I'll pick just one relative to PE; Apple only reports 1/8 of their income for the iPhone in any given quarter, which makes your analysis of 2008 earnings flawed.

    That aside, I suspect most that are invested in Apple are looking at the stock on a forward looking basis and recognizing the very low market share they have in regard to Mac and smartpones, thus seeing the gross opportunity that represents.
    Reply | Link to Comment
  •  
    Jul 28 08:32 AM
    Bellehumeur got it half right - Apple designs for consumers, not engineers. But the here's the difference: Crocs was cool and no longer is cool - it's a fashion item, nothing more needs be said; consumers don't buy Apple because Apple products are cool, consumers buy Apple because Apple products are easy to use and go wrong less often than their competitors. Sure, Apple is cool, but that's beside the point.
    Reply | Link to Comment
  •  
    Jul 28 09:20 AM
    Andy, Andy, Andy. If you'd like to be respected as a columnist, you might want to start being respectful of others.

    "Valuate"?
    Reply | Link to Comment
  •  
    Jul 28 09:38 AM
    Valuate is a term.

    www.wordreference.com/...

    www.yourdictionary.com...

    www.merriam-webster.co...

    You should do your research before condescending. And I'll call people out when they deserve to be called out. One's reasoned analysis should stand alone notwithstanding the brashness of its delivery.
    Reply | Link to Comment
  •  
    Jul 28 10:21 AM
    1. GOOG is expected to put up $20 earnings in 2008 and it has $40 cash per share. SO, net of cash it is valued at 22.5x 2008 earnings.
    2. AAPL EPS means little. Show me the cash! They have generated $6 per share of cash in the first 3 quarters and will generate at least another $1 to $1.50 per share in cash in Q4. With $23 per share cash on the balance sheet, it trades at about 18x 2008 cash flow net of cash - and you are paying for that figure for the year ending in 2 months! It gets even cheaper if you look at 2009.
    3. RIMM might appear most over valued but it has the best growth potential. iPhone is serving to HELP them in a big way by bringing tons of attention to the smart phone space. Seems strange, but the reason for this is simply price of data. They will ride the demand elasticity curve for data services as they continue to work with carriers to offer lower data plans (tmobile $10 BB plan?, pre-pay BB plans?) The company has said they see huge volume increases anywhere they get the carrier to lower data pricing. Demand elasticity is huge for data services - and they are the only handset maker who is in a position to work with carriers to lower data prices as RIM offers a compelling service with their email system. Combine that with cheaper handset prices (cheap flip, curve update coming) and you shouldn't be focused on whether the Bold or Thunder competes with the iPhone, but you should watch home many folks buy the BB flip (aka Kickstart) instead of that cheap LG, samsung, or moto when combined with a low priced email plan because the customer gets a great service for a small incremental fee.
    Reply | Link to Comment
  •  
    Jul 28 10:59 AM
    Andy Zaky - I am a fan of yours, and I agree with your analysis. But I think it would carry more weight if it was less disrespectful.
    Reply | Link to Comment
  •  
    Jul 28 12:36 PM
    You bought Apple and you held it 6 Mos. and sold it. I strive to shoot for Long Term Capital Gains. And, Macs and iProducts have huge upside yet to be tapped, IMHO.

    I like GOOG becuase, again, LT Cap Gain. The recession will start to ease early next year (again, IMHO).
    Reply | Link to Comment
  •  
    Jul 28 01:54 PM
    There is room for Apple to grow its PC sales, but it will have to lower costs and cut margins if it wants to grab market share.
    MSFT owns the OS and will continue to do so for the near future, Apple is not going to take much market share until they create a robust flexiable OS. At the moment they simply do not have one.
    I am not some MS lover or Apple basher, just telling it like it is.
    Apple is great if you dont care about money or being highly limited in software and hardware choices.
    As to the iphone? Get to europe and learn , it is a big bad world out there Phones come and go faster than stock pickers.
    Reply | Link to Comment
  •  
    Jul 28 02:30 PM
    Definitely a lot of opinions when it comes to stocks, that is for sure...Hey, what makes this page great is that everyone can have an opinion!

    A few points:
    - The overall point of this article was to see what others thought about these companies evaluations. I thought that I made it clear that I liked the long-term prospects of all of these companies....apparentl... I didn't.
    - The Projected earnings that I got for the stocks were from a combination of 3 recognized sources. If I did miss much of the earnings as people have pointed out, then it appears that many of the large investments houses / Financial pages do as well. One can only evaluate based on the fact that are in front of them.
    - Everyone has their opinion, but you can't tell me that people lined up all night for Apple because "Apple products are easy to use and go wrong less often than their competitors." They hype their products better than anyone. My point is that they are still in a market where consumers can be fickle. If Apple's Sustainable advantage was so good, then why did they go in the tank for over a decade?
    - I know RIMM's model well. For full disclosure, I have a number of awards from them on my shelf, as I help to launch their product as a consultant, and as an Associate Director in the Sales for a carrier. They are a great company....you missed my point. It is their evaluations that are bad.

    Love the comments, everyone! It's what makes this page fun!
    Reply | Link to Comment
  •  
    Jul 28 02:53 PM
    I own AAPL stock, yet I do not own an AAPL product. I am not into the fashion aspect of the product, but the reliability of it. As a Windose user for years my next computer will be an Apple notebook as I have always had issues with windows. XP has been the most stable, but it is slow and annoying. The only reason I don't have an iPhone is because I need to let my Verizon service contract expire first, which will be awhile, stupid me.
    So for some, I guess Apple is just a fashion thing, but for many others Apple is a more reliable product that is focused on the consumers needs.
    That said, I wish I had sold at 200, bought at 120, and sold at 190, but hindsight is 20/20. Right now the stock is about as good as it is going to get, maybe down to the 140's again briefly if more economic worries.
    Hope they take care of MobileMe soon, getting sick of hearing about it.
    Reply | Link to Comment
  •  
    Jul 28 06:32 PM
    Isn't the Mercedes built by Chrysler?

    Oscar Wilde said the stock market is full of men who know the price of everything and the value of nothing...
    Reply | Link to Comment
  •  
    Jul 28 07:40 PM
    Tuskagee -- Good quote. There is no way of ever knowing the exact value of anything in this world, as the only value that one can place is what someone else is willing to pay for it......That is how you determine the price of a Picasso, a house or a stock. I like Buffett's expression of a Margin of Safety....in case one does make such an error.

    FYI -- Mercedes owned Chrysler and devested itself last year, in case you weren't making a joke.

    Larry
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  •  
    Jul 28 09:16 PM
    This is a good article.
    Reply | Link to Comment
  •  
    Jul 28 09:19 PM
    Larry, "divested"..... may I add you obviously have a 'vested' interest in RIMM, so your valuation needs to be greatly discounted.

    You may keep your awards though.
    Reply | Link to Comment
  •  
    Jul 29 12:07 AM
    Fatwollit, Crocs were never cool :p but they were in fashion. That being said I don't believe you can compare a fashion company to a technology company and find a valid parallel.

    I believe the most interesting thing that AAPL has in its favor right now is that the more computers it sells the more computers it will sell. By that I mean, as Apple computers grab more market share, more software will be available for them, more people will see them as a viable alternative.
    Reply | Link to Comment
  •  
    Jul 29 12:09 AM
    All very interesting, and yes these are good picks for good but overvalued companies. One interesting point that has been made by several commenters is that GOOD and AAPL generate lots of cash. Very true, and an excellent attribute for any company. Both also have little or no debt - another huge positive. But my question for those of you long these guys is what are they using their cash for? They're growing sales, but not in ways that seem to make use of the cash. From what I can see it's just piling up on their balance sheets. Do you think they're keeping their powder dry for the real downturn yet to come, planning to invest it in something great, or just not bothering to pay their shareholders? I'd love to see these guys on the dividend achievers list. They belong there. But they both pay nothing. Why?
    Reply | Link to Comment
  •  
    Jul 29 12:25 AM
    Thanks for the grammatical correction, Tuskagee. As for my bias towards or against RIMM, I love the company. I've known many of the executives from the time that they used to make Cellular modules for Vending machines. I had one of the first 850 devices ever made, and have had a BlackBerry on my waist since 2000. If anything, I would be tilted in favour of them......Funny thing is that their evaluation probably looks better now than it ever did!

    Bearfund -- interesting point. I've never understood why a company like Apple wouldn't pay a dividend. Google is still in acquiring mode, so they get a pass for now....I do know in the future never to critique Apple though! Seems to draw out the claws from people....
    Reply | Link to Comment
  •  
    Jul 29 02:07 AM
    @jackdee ..."There is room for Apple to grow its PC sales, but it will have to lower costs and cut margins if it wants to grab market share."

    If you understand the recent actions and report by Apple you should see that is precisely what they are doing.

    "MSFT owns the OS and will continue to do so for the near future, Apple is not going to take much market share until they create a robust flexiable OS. At the moment they simply do not have one."

    Oh, my, you surely have not tried a Mac, have you? Nor read anything about its Unix base apparently.

    "Apple is great if you dont care about money or being highly limited in software and hardware choices. "

    This is an argument that may have been of use several years ago. No longer. Granted the hardware choices are fewer but you are getting a balanced platform that is aligned to the OS thereby resulting in fewer conflicts. That more than makes up for the so called lack of hardware choice. And there is plenty of software, more every day.
    As for price, my niece recently specked out Windows machines vs a Mac and she was surprised to see that by the time she upgraded the basic Win machine to meet the Mac specs the price differential was non existent. And then there is all the Apple software that "just works". Any guess as to what she purchased? Oh, and she is "happy as a clam".

    @bearfund: Yes, I also wish Apple would give a dividend. But they are using some of their cash evidenced by the purchase of the chip manufacturer P.A. Semi. Don't be surprised if you see new chips in future products that aren't Intel.

    @Larry: "If Apple's Sustainable advantage was so good, then why did they go in the tank for over a decade?"

    First of all you can't possibly compare the PPC and pre OSX days with now. Hardly. But there had to be something that kept Apple alive through all those "doomed" days where anytime Apple was mentioned it was with the word "beleaguered"... The fan base knew there was something worth supporting despite going up against a monopoly. Any other company would have died quickly under those circumstances.

    Whether you think a stock is too expensive has to do with your short or long term outlook. If you are in it for the quick gain, then maybe so, but down the road you'll be wishing you had held on.
    Reply | Link to Comment
  •  
    Jul 29 08:53 AM
    Apple is expanding all over the world and the iphone is only a year old. it's NOT a fad. these are great products with terrific design and tech support and a company with oodles of extra $ and no debt and makes more $ hand over fist, and that's without even counting the iphone! the moat is huge. i'm also a value investor and Apple has made $ for me in the past and will continue to do so in the future.
    Reply | Link to Comment
  •  
    Jul 29 09:13 AM
    larry ---in short you feel all the houses like GS and Lehman Brothers etc are all wrong ---they evaluate the stock from $215 to as high as $257 per share---
    do feel like a voice crying in the wilderness
    Reply | Link to Comment
  •  
    Jul 29 09:17 AM
    kbear - excellent post and right on. It amazes me how so called analysts fail to really understand this company, its products, its customers and why they are so passionate about their products, and what the true market potential is. One area where I think you are wrong however is on lowering the margins to increase market share. Apple is forecasting just 3 or 4 pts reduction in GM, this won't amount to much of a cost savings to have a real impact on iMacs or MacBooks though - in the range of $30 - $70, which is not enough to drive sales on a cost basis. I believe they will continue with their same strategy of holding prices overall (with few exceptions) and continuing to upgrade performance with new components that cost a little more but will come down over time. Another explanation is that as component costs rise during these global inflationary times, they will absorb some of the cost increases. But not lower prices. They don't need to as their market continues to grow globally, and they have significant potential on the upside, especially with the expansion of their consumer base internationally, which will result in other Apple product sales. Apple is a growth machine in the near and long term.
    Reply | Link to Comment
  •  
    Jul 29 09:21 AM
    I got in AAPL in the $40 range and rode that "sucker" all the way to $60 before some analyst scared me out. Jeesh. I think it's going to be like MA and have an easy ride to $300 and leave dolts like me saying "it could have been..."
    Reply | Link to Comment
  •  
    Jul 29 09:49 AM
    It is funny all the defensive comments here. If your stock has a PE over 30, it has a lot of downside risks. When you are buying companies with high valuations, you are speculating on growth and there is no guarantee of that.

    It doesn't matter how good the company is, if it can't meet growth expectations, they price will get knocked down.
    Reply | Link to Comment
  •  
    Jul 29 08:54 PM
    Mental note -- If you want to get a lot of comments on your article, just bash Apple!

    BrianZach -- your point matches to what I am saying. Apple is a great business, just an expensive one.
    Reply | Link to Comment
  •  
    Jul 30 10:36 AM
    To Andy Zaky:

    "Valuate is a term."

    You'll note that I never said it wasn't a term or, more specifically, a word. "Irregardless&quo... and "ain't" are also words, but are generally thought of as non-standard. "Value" would have been a better choice in this case.

    "You should do your research before condescending."

    You're stretching when you say I was being condescending. And you should grow up a bit before calling a FELLOW COLUMNIST an "idiot." Respect begets respect; you are deserving very little.

    "And I'll call people out when they deserve to be called out."

    "Called out"? What shall it be, then - pistols at ten paces? Why are you so angry?

    "One's reasoned analysis should stand alone notwithstanding the brashness of its delivery."

    You are confusing two things here: your analysis of Apple's earnings, and your attacks on this writer. I have not (yet) questioned any of your analysis. However, you seem to need to learn that language matters, that words matter, that everything you say and write is processed by others to form an opinion about you, and will color all your future discourse. Sounds like you've chosen how you want to be viewed. So be it.

    My advice, wanted or not, is for you to drop the attitude and stick to the analysis. But if, for some bizarre reason, you want to try to debate points of proper English usage you would do well to find another opponent.
    Reply | Link to Comment
  •  
    Jul 30 12:37 PM
    AZ: Looks like seekingalpha.com agreed with me, as they removed your post. Pretty harsh action for the site to take against a contributor, don't you think?
    Reply | Link to Comment
  •  
    Jul 31 09:02 PM
    BS-D.....When one writes an article with an opinion (my work is more opinion than factual, as no one really knows where these stocks will go), you have to expect that you will have some objectors. Everyone is entitled to their opinion, and I welcome the idea of hearing what people think. We all read numbers and evaluations differently.

    One important part to remember is that most people on SA don't do this for money.....I've never seen a cent for anything. We do it to share ideas with like-minded people, and hopefully, cause some discussion.

    In terms of some of my word choice, I used "ain't" as a way as a form of emphasis (I have a Masters, I know it isn't a grammatically correct choice).

    In terms of this article, perhaps I should have expected that some people would not grasp the concept of it. My comments spoke about the attributes of Apple, and its dominant market share. Amazing how calling it expensive set off a great uproar.....the stock corrected around 35% at one point this year, so someone else must have thought it got out of control as well.

    I'm going to continue to post articles, and I welcome all comments...good or bad!

    Cheers and thanks for reading!
    Larry
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  •  
    Aug 01 09:09 AM
    Larry B.

    Thanks for the article......interesti...

    RiverCat
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  •  
    Aug 02 06:49 PM
    Anal-lists estimates:

    i remember seeing $150 price targets for VMware.....i hope they revised it down to $75.

    and i am sure there were such expectations even from Sbux and Crox.

    i think most anal-ist are only in the game to pump or dump....they want to make money for their employer..
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