Six ‘Sky-High’ Stocks Have Limited Upside Potential
By JOHN DORFMAN
Here’s a list of the priciest stocks in the market. I call it the Sky-High Six.
Quite simply, the ranking features the six stocks that sell for the highest multiple of earnings per share. One purpose of the list is to generate ideas for short selling, which is betting that selected stocks will drop.
Not every company with a stratospheric price-earnings ratio deserves to be sold short. But, in my opinion, most deserve to be avoided. A p/e ratio above 100 is often a sign investors have become infatuated with a stock and lost touch with reality.
To be eligible for the Sky-High Six, a company needs a market value of at least $1 billion. Among the 1,213 stocks that qualify, the highest p/e ratio belongs to LSI Logic Corp. of Milpitas, Calif.
LSI Logic, whose customers include Sun Microsystems Inc. and Compaq Computer Corp., was a leader in putting a microprocessor, memory and logic on a single chip. Last year, it had sales of $2.7 billion.
Recently, Chief Executive Wilfred Corrigan said he expected $250 million in sales over the next three years from new agreements with Dell Computer Corp. and three other computer makers he didn’t name.
LSI earned two cents a share in the past four quarters. The stock trades at about $19.25, giving it a p/e of 962. The average p/e for the S & P; 500, by comparison, is 45.
Steakhouse comparisons
You can argue that many p/e ratios are high today because earnings are depressed. To deal with this period of declining corporate profits, I devised what I call the “steakhouse p/e” and the “malt shop p/e.”
The steakhouse p/e is a company’s price divided by its peak earnings, the best annual earnings it has ever had. For LSI, the steakhouse p/e is 16, based on the $1.21 the company earned in 2000.
The “malt shop p/e” is computed by dividing a company’s stock price by the third-best earnings the company has posted in the past 10 years. LSI’s third-best year was 1997, when it earned 59.5 cents a share, making its malt-shop p/e 32.
I don’t think LSI is a bad company or a bad stock, but its steakhouse and malt-shop p/e ratios are higher than I’d choose to pay.
Electronic Arts Inc., the largest U.S. producer of video game software, earned 6 cents a share in the past four quarters. At $54.81, its p/e ratio tallies 914.
Electronic Arts’ steakhouse p/e is 56 and its malt-shop p/e is 82. That’s a lot to pay for a company in a business as faddish as video game software.
Third among the Sky-High Six is Viacom Inc., with a nickel a share in trailing earnings and a stock trading near $42. That works out to a p/e of 839.
Viacom, whose wonderful collection of entertainment and publishing properties include Paramount Pictures, the CBS television network and an 82 percent interest in the Blockbuster video chain, has a steakhouse p/e of 64 based on peak earnings in 1993. Its malt-shop p/e is 98.
Like its rival AOL Time Warner Inc., Viacom is a sprawling empire of companies. Some day, I believe someone will take both empires apart, sell the pieces and make stockholders a lot of money. But my best guess is that such a day is far off.
The fourth highest p/e belongs to Medarex Inc., a biopharmaceutical company in Princeton, N.J. that is working on anti-cancer drugs. Its earnings for the past four quarters were 3 cents a share and the stock fetches $22.11. Voila, a p/e of 737.
Medarex has had an annual loss since it became a publicly traded company in 1991, so I can’t calculate its steakhouse or malt-shop p/e.
COR Therapeutics Inc., a stock that I have sold short in some client accounts, makes drugs for treating or preventing severe cardiovascular diseases. Last year, the South San Francisco-based company posted a loss of $16.7 million on sales of $104.7 million.
COR’s earnings for the past four quarters totaled 4 cents a share, and the stock sells for $21.79, so the p/e ratio is 545. The company has not posted an annual profit since it went public in 1991.
Analysts expect COR to earn 14 cents a share this year and 72 cents a share in 2002. If they’re right, the stock is at 30 times steakhouse earnings, which have yet to be served up.
Good companies, bad stocks
Silicon Laboratories Inc., a maker of specialized integrated circuits used mostly in telecommunications, trades at 493 times trailing earnings of 6 cents a share. The steakhouse p/e is 67, based on 2000 earnings of 44 cents a share. The malt shop p/e can’t be calculated because the company has been publicly traded only since March 2000.
Most of the companies in the Sky-High Six are good companies, and some are even excellent. But I doubt there is an outstanding stock in the bunch. My guess is that, as a group, they will perform substantially worse than the overall market. I intend to track them and report on the Sky-High Six at least twice a year.
John Dorfman is a columnist with Bloomberg News.
