6 High-Priced Stocks Worth the Cost
By John F. Wasik
Value is determined by comparing a stock’s price to such fundamental measures as earnings, revenues or book value (assets minus liabilities). So if a stock trades at $10 and the underlying company has earned 20 cents a share, the stock sells at 50 times earnings. Compare that with a $100 stock that trades at ten times earnings of $10 per share. In terms of true value, the $100 stock is the cheaper of the two (although that doesn’t necessarily mean it will perform better in the future).
History shows that you can earn great returns even if you buy a stock with a sky-high price. Consider Berkshire Hathaway (symbol BRKA). If you had invested in Warren Buffett’s company in September 1990, you would have paid an outlandish $5,900 per share. Today, the stock goes for $109,000, a nearly 20-fold increase.
Several factors not strictly related to a company’s performance can determine its share price. One is how long a firm has been in existence. Obviously, a company that has been around for a long time has had more opportunity to appreciate than a company that went public last week. The price at which a firm sets its initial public offering can be a big factor, too. Most companies (not counting penny stocks) go public at between $10 and $20 per share. But when Google went public in 2004, its IPO price was $85, virtually guaranteeing that it would soon hit triple digits.
The final -- and perhaps most important -- determinant of share price is a company’s attitude toward stock splits. A split changes none of a stock’s key measurements of value. But many firms believe investors will find their stocks more appealing if the absolute price doesn’t get too high, and so they split their stocks regularly. By contrast, Berkshire’s Class A shares reached six digits not only because of the company’s long and successful record but also because Buffett despised splits (he consented to splitting Berkshire’s Class B shares early this year to facilitate the purchase of Burlington Northern).
As of May 21, 44 stocks trading in the U.S. fetched $100 or more. Below we focus on six with bright prospects. (All share prices are as of the May 20 close.)
Internet giant on sale
Google’s once-unstoppable shares (GOOG) are in retreat. At $472.05, the stock is more than one-third below its record high, set in November 2007. It’s having a particularly rough 2010, dropping 24% through May 21 because of concerns about slowing growth and Google’s decision to effectively shutter its search engine in China.
The good news is that the stock’s valuation has fallen to a level that would have seemed unimaginable just a few years ago. It sells for 17 times estimated 2010 earnings of $27.82 per share. As recently as 2007, Google’s average price-earnings ratio for the year was more than 40.
And although Google’s growth is clearly slowing (not surprising, given that revenues nearly hit $24 billion last year), the company has a firm grip on its primary market and plenty of opportunities to expand. “Paid search” -- in which Web-site owners pay a fee to have their sites receive top placement in search results -- accounts for nearly all of Google’s revenues. This segment should continue to grow as advertisers continue to flee to the Internet. Google is also working on its own PC operating system -- a direct challenge to Microsoft's Windows empire -- and is developing an Android-based tablet computer to rival Apple's iPad.
The Mountain View, Cal., company has a pristine balance sheet: no debt and a cash stash of $26.5 billion. "Google is a core holding trading at a compelling valuation," says Scott Kessler, an analyst at Standard & Poor's. S&P’s 12-month target price for Google is $725.
A cultural phenomenon
Until the current correction got under way, the face of the bull market was Apple (AAPL). The stock soared from $78 in early 2009 to a peak of $272.46 in April, adding more than $150 billion to Apple’s market value. It closed May 21 at $242.32
With its iPod, iPhone and iPad, Apple is not just a technological innovator but a cultural phenomenon. The Cupertino, Cal., company shipped almost nine million iPhones and three million Macintosh computers in the quarter that ended March 27, and it sold two million iPads within two months of the device’s release on April 3. Although the iPad faces robust competition, it looks like a game changer: It’s not merely a user-friendly tool for providing information; it delivers with élan. As for the iPhone, Apple is working on a new operating system that will allow users to multi-task.
Despite the stock’s ascent, Apple shares are not outrageously expensive. That’s because the appreciation has been commensurate with profit growth. Apple sells for 18 times estimated earnings of $13.34 per share for the year that ends this September. Like Google, Apple has a fortress-like balance sheet. The company holds $23 billion in cash and has no debt.
A bet on the economy
From the sublime to the mundane, we move to W.W. Grainger (GWW), a leading distributor of industrial supplies, such as fasteners, tools, motors, pumps and safety equipment. The Lake Forest, Ill., company sells more than 300,000 products via the Web and through more than 600 branches, mostly in the U.S. and Canada.
As you might imagine, Grainger’s business is sensitive to the ups and downs of the economy. Earnings dropped 6% in 2009, but analysts see them rebounding 8%, to $6.08 per share in 2010. At $102.77, the stock sells at 16 times that estimate. The balance sheet is solid -- cash holdings of $548 million exceed long-term debt -- and the company has raised its dividend 39 consecutive years. Grainger has no exposure to Europe, so the company’s fortunes hinge primarily on the U.S. economy. If it continues to recover, Grainger’s shares should perform well.
Unless you're a gearhead, you won’t find much glamour in AutoZone (AZO), the nation’s largest retailer of auto parts. The Memphis-based company operates some 4,500 stores in the U.S. and Mexico. That number is up 50% from ten years ago, providing one clue to how AutoZone has been able to boost profits by a factor of four since 2001.
A couple of trends put AutoZone shareholders in the driver’s seat. For starters, baby-boomers love old cars. That’s a huge market -- mostly men -- who relish the opportunity to fix up a classic Camaro or Thunderbird. A high unemployment rate also bodes well for AutoZone because people without a job or worried about losing a job hang on to their cars longer. That means drivers need to spend more to keep their vehicles going. AutoZone also has plenty of room to grow in Mexico and in the professional-repair market. At $183.47, AutoZone sells at 13 times estimated earnings of $14.10 per share for the year that ends this August.
Stealth school stock
The latest circulation figures for the Washington Post, the flagship of the Washington Post Company (WPO), paint a grim picture. For the six-month period that ended March 31, weekday circulation fell 13.1%, to an average of 578,500 (compared with a peak of 830,000 in 1994), while Sunday sales dropped 8.2%, to about 800,000 (compared with a high-water mark of 1.1 million in 1992). The company also recently announced that it has put its troubled Newsweek magazine on the block. Meanwhile, the stock, at $483.67, is down 52% from a record high in 2004 of just under $1,000.
Look beyond the albatross of dead-tree media, though, and you find the company’s crown jewel: Kaplan Inc., which started as a provider of test-preparation services and is now one of the world’s fastest-growing for-profit education companies. Kaplan’s annual revenues have grown at a compounded rate of 27% over the past ten years, to $2.6 billion. That represents 58% of the company’s sales.
Analysts are looking for a big rebound in earnings this year following weak results in 2008 and 2009. The stock sells at 23 times estimated 2010 earnings of $20.58 per share. That may seem high, but it’s reasonable if you view the Washington Post Company as the education-services provider it is rapidly becoming rather than as a traditional media company.
Poor man’s Berkshire
Charlie Munger, 86, may not get as much ink as his 79-year-old sidekick, Warren Buffett, but Munger is no slouch when it comes to business matters. In addition to serving as vice-chairman of Berkshire Hathaway, Munger is chairman, president and chief executive of Wesco Financial Corp. (WSC), a mini-conglomerate with interests in insurance, furniture rental and steel warehousing.
Wesco is kind of a low-rent version of Berkshire Hathaway, which owns 80% of it. Munger admitted as much in Wesco’s 2009 annual report, saying the company was “not an equally-good-but-smaller version of Berkshire Hathaway.” But Wesco’s shares are also cheaper than Berkshire’s. At $357.05, Wesco trades for just a shade above book value, the preferred measure of value for insurance companies. Berkshire, by contrast, trades at about 1.2 times book value. Morningstar estimates Wesco’s fair value at $455 per share.