When P/E Ratios Become Challenging (LVS, NFLX, WYNN, AMZN, WYNN, BIDU, RHT, OPEN, CRM, AAPL, GOOG)

The most common method of valuing stocks is the good old P/E ratio that measures the share price versus the trailing 12-months earnings.  For many tech and biotech stocks, that means that when some of the growth stocks become the flavor of the month that triple-digit P/E ratios are very common.  Most investors should be concentrating an ability for a company to meet and beat expectations and what growth rates it will have for the year to two years ahead.

An interesting research note from Zacks Research highlighted ‘Nose-Bleed Valuations’ now that stocks are at two-year highs.  While Zacks says that the S&P 500 index doesn’t look very expensive at about 15-times forward estimates, the verdict is that it is neither cheap nor expensive.  But there are those with P/E ratios of 50 and higher that need to be questioned.  Zacks noted that 12% of the S&P 500 companies are now trading at 25-times forward estimates or higher, and 18 companies in the S&P 500 are trading with P/E ratios above 50.

Some of the companies listed are far from being in the S&P 500 Index, yet the ratios stand out measurably.  Amazon.com Inc. (NASDAQ: AMZN) and Wynn Resorts Ltd. (NASDAQ: WYNN) are at 67-times and 68-times forward earnings estimates.  Netflix Inc. (NASDAQ: NFLX) trades at 61-times expected earnings and Baidu, Inc. (NASDAQ: BIDU) trades at 76-times forward earnings.  The real valuation argument is that Zack’s stresses not to ignore valuations and some of these individual names may simply be too hot to handle.

The problem is that valuations can get inflated and inflated, often killing short sellers.  Those same nose-bleed P/E ratios spook off many investors, who often miss runs of 50%, 100%, or far more.  Netflix Inc. (NASDAQ: NFLX) has always been predicated that it had to keep its robust growth alive with millions more of Americans signing up.  The death of Blockbuster and other video rental stores has helped it.  Baidu, Inc. (NASDAQ: BIDU) has been a direct beneficiary of Google Inc. (NASDAQ: GOOG) having its own version of a China War when it comes to search and privacy.  OpenTable, Inc. (NASDAQ: OPEN) sports a triple-digit forward P/E ratio and it needed to blow away earnings and show a solid sign-up from restaurants just to hold its own, yet shares are above $68 and they were below $62 before this week’s earnings.  What about Salesforce.com Inc. (NYSE: CRM)?  The SaaS model has always given it a super-premium multiple, and it trades with a P/E of roughly 200 and closer to 96-times Jan-2011 earnings and almost 75-times Jan-2012 estimates.

*forward P/E based on Zacks Research internal data

What about current tech favorites with low P/E ratios?  Apple Inc. (NASDAQ: AAPL) hit a 52-week and all-time high again today at $320.18, yet its trailing P/E ratio is only about 21 and it trades at close to 17-times next year’s earnings estimates (Sept-2011) per Thomson Reuters estimates.  Google Inc. (NASDAQ: GOOG) is expected to have 17% earnings growth in 2011, yet it trades at under 19-times Thomson Reuters estimates for 2011.  These did formerly have high P/E ratios, but that has not prevented them from outperforming stocks in general in the last decade (almost a decade for Google).

The most important measure is that high P/E stocks often stay high, but when they break it often looks like a high-speed blowout.  Many of these never really pull back much more than the market and in that case the earnings just catch up to the price.  That is PEG ratios come into play, price to EBITDA, revenue multiples, book value multiples and many more metrics.

JON C.  OGG