lundi 15 juillet 2019

When the perfect stock is expensive

Usually, great stocks can only be bought at a high price like 20 or 25 times current earnings. But when they reach another level, such as 30 times forward earnings, an investor should ask himself some questions, even if everything looks great with the stock.

For instance, I own two small positions in Visa and Mastercard. Both are perhaps the best companies in the world. You may disagree with that affirmation, but you can't disagree that both are incredible businesses and their decline looks far away.

However, both are currently priced at about 30 times next year's earnings. It's a lot, even for two companies that make a lot of money and that are very well managed. But should I sell them to buy a cheaper company not as great as them?

Maybe. Sadly I'll only know the answer to that question in a few years.

But here's a short analysis with which I'll decide to sell or keep them. Please, note that I know that both companies have incredible margins, good ROE (Visa) and unbelievable ROE (Mastercard). Both are growing a lot every year and that trend shouldn't stop. And both have a name that everybody knows. So, that approach wouldn't be valid for every stock. Actually, that approach is only valid for very special stocks (5% of stocks).
 
Mastercard
Current PE ratio: 47
Forward PE ratio: 31
Average PE last 5 years (2014-2018): 32

Visa
Current PE ratio: 37
Forward PE ratio: 29
Average PE last 5 years (2014-2018): 32

These are stocks that you can only hope to buy at around 25 times current earnings in a panic. Or at 20 times current earnings in a big crisis like 2008-2009. Otherwise, they'll be sold for 30 times current earnings or more.

If we look at the numbers above, both stocks are currently selling at a forward price that's a little smaller that their average PE for the last 5 years. It's still expensive, but on an historical perspective, with future potential similar to past performance, it looks like the price to pay.

Of course, if I would have a 10% position in both stocks, my reaction would be different. But with a small position, you can be more tolerant towards a high price. That's your job to mitigate that "risk" with some cheaper stocks in your portfolio.

That's where the real game is.

10 commentaires:

  1. What is your portfolio turnover? Do you go regularly in and out the same positions during the year (like Turtle Creek)? Do you calculate your own DCF fair value estimates or rely on analysts (if yes, how do you evaluate their reliability/credibility)? How do you deal with qualitative changes in management (like SJ CEO stepping down a couple days ago) or founders aggressively selling out their position (CCL, DOL, etc.)? How do you avoid catching falling knives or watering the weeds in your garden (like me averaging down on CPH, CXR, HLF, HCG, and more recently LNR)? Do you look at momentum? Do you set up stop-losses on your positions? Have you nibbled on TC or TOY on their 2019 descend?

    I had bad experiences trusting analysts' (and company management) projections and I think they have a bias to promote high turnover so the brokers can make money (or the managers can quietly accommodate necessary volume to have a stop-loss margin call in carribean). Lots of companies have been also pushing down market expectations recently so that analysts downgrade estimates so that the companies will then magically still beat the estimates even though their performance was worse or mediocre at best. There seems to be lack of genuity on all sides of the industry with everyone rubbing their back and profiting off of stupid retail buyers like me.

    I have only a small portfolio so turnover costs are too high for too much portfolio optimization. As a result, I usually try to hold equal size holdings and in new year (in TFSA) usually add a little bit to the OK quality laggards to lift them up, buy an entirely new position, or in rare situations buy an oversized one or two loser positions with intent on selling down in near future after recovering losses (like HCG last year).

    In my very limited experience, however, the most expensive stocks have resulted in the greatest results (CSU, SUM) and the cheapest ones have always burned me and caused a lot of worrying. Quality and peace of mind are not cheap. After reviewing annual reports from mutual funds which had the losers in their holdings on the internet, I have also noticed that full-time professional managers also make many mistakes and regularly sell their losers and move on. I guess, I still have not learned to only pick the "very special" (top 5%) stocks, as written in Penetrator's disclaimer. Thank you for your article.

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  2. I have a position in both Mastercard and Visa as well. They will always be expensive to buy.

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  3. Is American Express (AXP) in the same category as these 2?

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    Réponses
    1. No! Good stock but no nearly as good as the 2 others.

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  4. sell when the average Joe and Sally in most African countries are paying for their cappacinos with these cards. until then, hold tight.

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    Réponses
    1. A huge percentage of the world population is just getting started with paying by plastic (or about to get started). This should be a growth period. It will take years to reach the point where the average Akeem and Aisha in Africa are paying for their coffee with plastic.

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  5. Just an aside...I think Angelo you asked about Opentext...They just signed an agreement with Mastercard as of below...They already have a partnership with Google...I think their CEO is trying to move forward to a more recurring revenue business model...They are reasonably priced right now...I see a good future ahead for them...just my opinion of course...

    https://www.opentext.com/about/press-releases?id=97F2E4B6CEBC47AE8EAE44E0D7BCD392

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    Réponses
    1. Deals with google and with Mastercard for Open Text and it is hitting new 52 week highs lately while still undervalued compared to other stocks in that sector.

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  6. Visa and Mastercard moat isn't penetrable in my opinion. The network, relationships with millions of banks in the world. Who can develop that?

    People who were worried about disruptors such as paypal, square, apple, google, alibaba etc for years but they all decided to partner with Visa and Mastercard instead of building their own network and relationships with millions of banks in the world. Why? Much easier and cheaper...

    There is a reason for its premium. Any idiot can run the business and it will still do very very well due to its business moat. I can't find any other business with bigger moat than Visa and Mastercard.

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  7. The best writeup on Visa.

    http://minesafetydisclosures.com/blog/2019/7/23/part-ll-an-overview-of-visa?format=amp&__twitter_impression=true

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