Don’t Buy a 'Valuation High'
Courtesy of Paul Price at Guru Focus
Imagine you just had the best week ever.
You got that promotion you’d been hoping for, along with a big raise. Your significant other said “yes” to sex. That worrisome biopsy result came back “benign.”
What are the odds that next week will be better, rather than more typical of your past? Probably pretty slim.
That same principle applies to investing. Periods when everything has been going great for a company, accompanied by superb stock price movement, are usually followed by regressions toward normal.
The financial media love to tout "good news" stories featuring stocks that have already done well. Columnists and newsletters feel smart explaining why the hottest shares deserved to have moved up dramatically. After all, those stocks are near all-time peaks, exhibit strong chart action, show positive momentum and sport nothing but satisifed shareholders.
Laudatory headlines like the one below can suck unsuspecting investors into buying right at the top. Who wouldn’t love to have achieved twice the long-term returns of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B)?
You can't get paid, though, for past performance. Henry Schein (NASDAQ:HSIC) made people money as it moved from near $32 and a P/E of 10.8x near 2009’s nadir, to north of $174 at 26.3x this year’s estimate before this Barron’s article was published. P/E expansion accounted for the majority of the stock’s huge multi-year gain.
The chart and data shown below accompanied the Barron’s story although the “late to the party” comment, the designated price point labels and the red arrows were added by me.
While praising HSIC’s 22% annualized compounded returns since 2000, Barron's never mentioned the stock’s riskiness due to its current sky-high valuation.
This month’s new high, at just shy of $181, saw momentum players paying 27.3 times 2016’s yet-to-be-achieved estimate of $6.63. Schein averaged only about 18.6x forward earnings during the previous eight years.
The most recent “best buying opportunities” (green-starred below) prove that value-seekers had plenty of chances to buy for much more reasonable valuations than today’s. Those who plunged into HSIC near 2008’s pinnacle (red-starred) at 21.4x earnings watched in horror as the shares quickly plunged by almost 50%. The non-dividend paying stock was cheaper on an absolute basis in December 2011 than where it sat almost four years earlier.
What is HSIC really worth?
Eliminate performance envy from your calculations, apply a normalized P/E to the current year’s estimate and you’ll arrive at a sub-$125 price target. That number is very much in harmony with what independent research outfit Morningstar came up with for Henry Schein’s fair value.
