With the stock market currently doing so well, numerous articles are popping up playing the bubble card. Personally, I don’t believe we are anywhere near bubble levels for equities, at least in the general sense. I do think there are certain stocks that are currently overvalued, but very few that I would describe as dangerously so. To me, the true definition of a Stock Market Bubble is when prices have become so ludicrously high, that the dangers of a catastrophic loss large enough to be considered almost permanent become imminent or at least quite obvious.
Starting in calendar year 1999 and then peaking in calendar year 2000, we saw a true stock market bubble emerge and inevitably burst in technology stocks. The following F.A.S.T. Graphs™ on three prominent technology stalwarts, Oracle Corporation (NASDAQ:ORCL), Cisco Systems, Inc. (NASDAQ:CSCO) and finally EMC Corporation (NYSE:EMC) provide quintessential examples of a true bubble. To clarify what they are depicting, we see the stock price closely correlate and track earnings both before and after the bubbles. However, during the bubble periods we see clear and undeniable insane valuation that fundamentals do not justify.
But perhaps most importantly, we see what happens when the stock market bubble inevitably bursts. Even after all these years have passed, none of these companies have seen their stock prices return to their bubble highs. This is the great danger of a true bubble, devastating losses that never recover. At least they never recover in a time frame that would be considered even close to acceptable. Only true stock market bubbles create this type of devastating loss.
Cisco Systems Inc
10 Stocks Approaching Bubble Territory
As I previously stated, even though we’ve had a decent run in the market, I don’t believe we are anywhere near close to bubble territory on most equities. I recently published an article, found here, illustrating that even after achieving all-time highs, there were very few stocks in the Dow Jones that were overvalued. On the other hand, as I screen the major stock universes such as the S&P 500 (INDEXSP:.INX), the S&P 400 (INDEXSP:SP400), the S&P 100 (INDEXSP:SP100), the NASDAQ 100 (INDEXNASDAQ:NDX), and the Fortune 500, I was hard-pressed to find 10 companies that I felt were anything close to bubble territory. The following portfolio review of 10 stocks approaching bubble territory compares their current P/E ratios to their estimated earnings per share growth, and their historical earnings per share growth. Based on these metrics, all 10 of these companies appear to be overvalued, and some even dangerously so. Later, when I examine each of these 10 companies individually, I will let you, the reader, decide whether or not any of them are in truth trading at bubble territory levels.
Cerner Corporation (NASDAQ:CERN) is a healthcare technology company with a legacy of trading above earnings justified values. However, we also see that each time the stock has risen above earnings justified levels in the past, that it inevitably returns to its earnings justified valuation (the orange line). On the other hand, because this company has such a consistent history of earnings growth above 20%, the power of compounding allows the company stock to achieve new highs within reasonable periods of time once each of its little mini bubbles burst. Perhaps this will once again prove true from today’s levels.
Church & Dwight Inc
Church & Dwight Co., Inc. (NYSE:CHD) is another example of a company with a strong and consistent record of above-average earnings growth. Historically, stock price has closely tracked this superior operating record. However, at current levels Church & Dwight’s stock price is clearly trading at unprecedented valuations. The question is, is it at bubble levels yet? The answer would be determined by how long it would take stock price to recover if this mini bubble burst.
Costco Wholesale Corporation
Costco Wholesale Corporation (NASDAQ:COST) is yet another example of a company with a legacy of its stock price trading at nosebleed valuations. Earnings growth has not been spectacular, in truth significantly weaker than our previous two examples. The company has been paying a dividend since 2004, but only offers an average yield. Nevertheless, the market has typically seen fit to price the stock at significantly above-average valuations. However, today’s overvaluation is even higher than normal. But can we call this a bubble?
Salesforce.com, Inc. (NYSE:CRM) appears to be the first example of what I would truly classify as a stock in true bubble valuation territory. The company does generate substantial cash flows, but its inability to bring those cash flows to the bottom line should be a cause of concern, at least in my opinion. If the stock were to trade at earnings justified levels, its share price could fall to between $10-$12 per share. I would classify that as a bubble.
3D Systems Corporation
3D Systems Corporation (NYSE:DDD) is another example of a stock that I believe is in bubble territory. Although the company has had very strong earnings growth post-great recession, I find it hard to believe that a 50% plus earnings growth rate is sustainable long-term.
On the other hand, when you evaluate the company’s earnings and price correlated graph since calendar year 2011, you do discover some justification for the current lofty valuation. But once again, I believe this growth rate is temporary, and therefore, unsustainable long-term. With that said, the consensus of nine analysts reporting to Standard & Poor’s Capital IQ, are expecting a five-year earnings growth rate of 26%. However, even that strong level of growth would not justify a current P/E ratio of approximately 60.
Fastenal Company (NASDAQ:FAST) is another example of a company that the market has routinely applied a premium valuation to. Consequently, based on historical norms, it could be argued that the stock is not terribly overvalued. On the other hand, based on earnings justified levels, the current P/E ratio of approximately 35 would not seem justifiable. There are plenty of companies with earnings growth rates as high and as consistent as Fastenal that can be purchased at much more reasonable multiples of earnings.
Rackspace Hosting, Inc.
Rackspace Hosting, Inc. (NYSE:RAX) might be the one true example of a stock trading in bubble territory that I have uncovered in today’s market. Although the market has historically priced the stock and a premium, a recent drop in earnings per share has already caused the stock price to be virtually cut in half as it has fallen from a high of $74.78 to under $40 per share. Nevertheless, I believe there is the potential for the stock to drop by even as much as another 50% if it were to move in alignment with