Most investors spend the bulk of their efforts on identification of “great companies” that they hope will make them rich over time. There are few stocks, though, that are really "buy and hold" wealth creators even when they post excellent corporate results.
Many of the best firms sell for such high multiples that they offer little chance for outstanding shareholder returns. For example, Expeditors International (EXPD, Financial) just completed a fine decade in which most of its key metrics surged by triple digits.
As of May 26, however, Expeditors’ share price was marginally lower than where it sat exactly ten years earlier. How could a stock with such great numbers go down over a full decade? It was simply too expensive back in 2006.
At its 2006 peak of $58.30 (farther back than the chart below illustrates) Expeditors traded for 55x forward earnings. Exactly 10 years ago it still fetched almost 47x that year’s final EPS of $1.06. At this January’s panic low, astute traders could have picked up the shares for a much more reasonable 17 multiple while also locking in a significantly better than normal 1.98% current yield.
Throw out January's momentary dip as a gross outlier and the May 26 valuation appears remarkably like the three previous "best buying opportunities" (green-starred below) of the last 10 years. Note, too, that each of those great moments was accompanied with historically excellent – for Expeditors –yields.
Momentum chasers who paid above average P/Es to get Expeditors near the tops in 2007, 2010 and 2013 (red-starred) overpaid and are still waiting to see decent, or even break-even, returns.
What is the lesson from all this?
Yearly fluctuations present good chances to trade into and out of even the best stocks if you keep a close eye on the value proposition. Failure to exit when traders become over enthusiastic often sentences you to long periods of underperformance.
Expeditors is a fine company but the stock is now more than 16% below its 2006 pinnacle. It also remains south of its peaks from 2007, 2010 and 2015 highs as well.
Taking profits, rather than continuously riding with Expeditors would have let sellers reenter their positions later and cheaper while redeploying their capital where it could do better while they waited for those more favorable entry points.
The converse, owning so-so companies at historically reasonable prices, can work out well even though their fundamentals are less exciting. Walmart (WMT, Financial) had been a high P/E stock when the market was booming, through about 2004. It averaged greater than 34x earnings in the three-year period 2000 to 2002.
By May 26, Walmart was available for about 16.9x its forward estimate, about half the former valuation. The company’s statistical progress over the past decade was less impressive than Expeditors', yet Walmart showed a better shareholder return as its multiple held pretty steady.
Growth for retailers in general, and Walmart in particular, has cooled considerably in recent times. Walmart’s 2008 to 2015 average P/E has reset to about 14.4x. Management only goosed the dividend rate by ratcheting up the payout ratio by 45% (from 33% to 48%) over the last five years.
The best five entry points over the last nine years (green-starred below) all came at below average valuations running from 10.9x to 12.7x. The three previous sojourns into above average multiples (red-starred) all remained under water as of May 27, years after traders “paid too much.”
Investors who piled in during late 2008, thinking Walmart would be a beneficiary of The Great Recession have been disappointed. Walmart was offered much cheaper during late 2015 and early 2016 than it sold for more than seven years earlier.
Based on its post-recession history, Walmart does not appear enticing today at close to $71. Apply a typical P/E to WMT's FY 2017 estimate, and the shares could still fall back another $5 to $10 over the coming year or two.
Everything works sometimes and nothing works every time
Once you understand a stock’s normalized valuation, though, you’ll have a valid benchmark to guide you. Buy only when the shares in question are available at a discount to that same stock’s typical multiple. Sell whenever the shares command a signficantly pricier than average P/E.
In almost every case you can expect to do better than simply isolating great companies which might not be trading for reasonable prices.
Disclosure: No positions in either Expeditors or Walmart at this time. I may purchase Expeditors shares or sell some Expeditors puts in the near future.
