What follows is a list of companies with PE ratios above 20, typically indicative of an expensive stock (although one-time charges often inflate figures). The least preferred on the Street is Verizon (VZ), which is rated a "hold." These companies are part of a variety of different industries: oil well services and equipment, airlines, communications, and biotech. I am most bullish on Merck & Co (MRK) due to its favorable risk/reward: that is to say, while the company has an undervalued pipeline that offers meaningful upside, its inelastic demand market offers safety from a double dip.
Schlumberger (SLB)
Schlumberger is rated near a "strong buy" and trades at a respective 21.8x and 13.3x past and forward earnings with a dividend yield of 1.4%. It has a beta of 1.4.
Consensus estimates for Schlumberger's EPS forecast that it will grow by 28.7% to $4.71 in 2012, and then by 22.1% and 19.5% more in the following two years. Of the 31 revisions to estimates, 25 have gone down for a net change of -3.7%. Modeling a CAGR of 23.4% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $85.94, implying 15.2% upside. Typically, for an investment to be considered a value play, the discount must exceed 25%. Given sovereign debt issues in Europe, slowing international growth, and domestic price pressure, the stock is overly expensive at the current moment.
Southwest Airlines (LUV)
Southwest is rated a "buy" and trades at a respective 41.8x and 8.9x past and forward earnings with a dividend yield of 0.2%. It has a beta of 1.1
Consensus estimates for Southwest's EPS forecast that it will grow by 93% to $0.83 in 2012, grow by 30.1% in 2013, and then decline by 0.9% in 2014. Assuming a multiple of 13x and a conservative 2013 EPS of $1.03, the rough intrinsic value of the stock is $13.39. Management is now scaling back operations, which indicates supply and demand imbalance. The uncertainty surrounding market equilibrium makes an investment risky at this point, especially with the PE multiple at the absolute high-end of peers.
Verizon
Verizon is rated a "hold" and trades at a respective 41.8x and 8.9x past and forward earnings with a dividend yield of 5.4%. It has a beta of 0.6.
Consensus estimates for Verizon's EPS forecast that it will grow by 2.9% to $6.41 in 2011, and then by 14.5% and 23.2% more in the following two years. Modeling a CAGR of 13.2% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $114.64, implying 20.2% upside. The company similarly trades at the high-end of peers while not meeting the threshold that I consider indicates a value play.
Qualcomm (QCOM)
Qualcomm is rated near a "strong buy" and trades at a respective 21.3x and 14.5x past and forward earnings with a dividend yield of 1.5%. It has a beta of 0.9.
Consensus estimates for Qualcomm's EPS forecast that it will grow by 11.6% to $3.57 in 2012 and then by 11.8% and 13% in the following two years. Assuming a multiple of 16x and a conservative 2013 EPS of $3.90, the stock has roughly 8.1% upside. Again, this small discount does not justify the company trading at the high-end of peers. While the 3G development in China represents a major catalyst, end-market demand in communications remains uncertain.
Merck & Co.
Merck is rated a "buy" and trades at a respective 26.4x and 10x past and forward earnings with a dividend yield of 4.4%. It has a beta of 0.7.
Consensus estimates for Merck's EPS forecast that it will be roughly flat, growing by only 10.5% to $3.78 in 2013. Modeling a CAGR of 3.5% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $48.86, implying 27.1% upside. This may be an attractive discount, but the fact that the company has one of the weakest pipelines compared with peers warrants holding out for biotech companies with greater upside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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