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Grahamites
Grahamites
Articles (288) 

Revisiting the SMID Nifty 50

Updated study of the current valuation levels of popular stocks

Awhile ago I wrote an article about the FAANG stocks and what I called the SMID high quality fast growth champions.

In the article I used the examples to illustrate the valuation concerns I had about those high-quality companies. Recently I decided to take a look at the valuation of those small-cap growth champions again. What I found is they have gone from expensive to almost irrationally exuberant. For comparison purposes I’ll use the same examples as I used in November last year.

1. Align Technology (NASDAQ:ALGN) is leader in the clear aligner dental market. The company had impressive growth (over 30% during the past several quarters). Adjusted earnings per share for 2017 were estimated to be about $3.70 at the time of my writing and turned out to be $3.89 per share. When I wrote the article, Align Technology was trading at 70 times 2017 earnings. Today it’s trading at 87 times 2017 earnings and 72 times estimated 2018 earnings. The analysts have also become more optimistic about Align’s future.

2. Abiomed (NASDAQ:ABMD) is one of the best performing stocks of the S&P 500 this year. It’s even making Netflix and Amazon look bad. Abiomed had strong growth in the past few years 43% growth in fiscal year 2016, 35% in fiscal year 2017 and 33% in fiscal year 2018.

At the time of my previous article, ABMD was trading at 88 times 2018 estimated earnings and almost 40 times 2021 estimated earnings. Today ABMD is trading at 165 times 2018 earnings, 114 times estimated 2019 earnings and 63 times estimated 2021 earnings. This is after a 10% drop from ABMD’s all-time high of $450 per share. The price also implies more than 18 times 2020 sales estimates.

3. Neogen (NEOG) is one of my favorite small-cap high-quality companies. It’s a great company with a great management team. The company has been a consistent solid double-digit grower for many years. Neogen’s share traded at 62 times 2018 earnings and more than 40 times 2021 earnings in November last year. Today the shares are trading at 70 times 2018 earnings and more than 50 times 2021 earnings. Unlike Align Technology and Abiomed’s explosive 30% growth rate, Neogen’s earnings are estimated to grow at 12-15% a year for the next three to five years.

4. Healthcare Service Group (NASDAQ:HCSG) is a bit like Neogen (NEGO) because it has also been a consistent double-digit grower in the small-cap space. The price tag was 40 times 2017 earnings and almost 25 times 2021 earnings at the time of my previous article. As of the latest close, Healthcare Service Group’s valuation has actually come down to 36 times 2017 earnings and only 18 times 2021 estimated earnings.

Most of the popular FAANG stocks have also had a good run so far this year with Netflix (NASDAQ:NFLX) and Amazon (NASDAQ:AMZN) leading the charge. Netflix was trading at over 110 times 2017 earnings when I wrote the article. Today it’s trading at 143 times estimated 2018 earnings.

In Amazon’s case, there’s a new earnings metric used by the analysts. It’s called options expense excluded adjusted earnings per sahre. In 2018, the previously used adjusted earnings per sahre estimate (including option expenses) is estimated to be about $12.60 per share but the options expense excluded consensus earnings per share estimate is $24 per share. By the new standard, Amazon is “only” trading at 71 times options expense excluded consensus earnings per share.

Conclusion

There’s a recent article by The Wall Street Journal on Greenlight Capital’s poor performance in 2018 as of June 30. Obviously David Einhorn (Trades, Portfolio) has been hurt badly by his basket of “bubble shorts.” In the case of Netflix, the P/E ratio has expanded from an already high 110 to an even higher 143. I can imagine the pain of short-sellers. They know it’s irrational exuberance, but how long can it last?

I wrote the following concluding words in November last year. Today I think they are equally, if not more applicable.

"I like most of the aforementioned companies – I think they are wonderful businesses and would love to be long term partial owners of them one day. I don’t own any of them now and I’ll be sitting on the sidelines if valuation continues to be this elevated. When investors have unrealistic investor expectations for high quality growth stocks, they inevitably pay a high price. And when the expectations prove to be too optimistic, investors who pay too much for the growth will inevitably learn the lesson. I see a considerate amount of greed, irrational exuberance, and excessive risk-taking in today’s markets for high growth high quality champions. In times like this, we should all remember Mark Twain’s wisdom: history doesn't repeat itself but it does rhyme."

About the author:

Grahamites
A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

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