Attack of the 50 P/E Stocks!

For more tales of financial frights, our Halloween special series, Avoid These 8 Investing Horror Shows, won't disappoint!

You know what scares me? Not the fact that half the country will be dressed up as Snooki for Halloween this weekend (although there's a nightmare). What scares me is overconfidence and overvaluation. It's investors who forget about room for error. It's valuations that rely on certainty in a world where our foremost experts can't make predictions better than a goat. These things lead to inevitable disappointments.

So what better way to celebrate Halloween and the tragedy of overconfidence than by highlighting a few 50 P/E (or close to it) stocks? Here are four:

Source: Capital IQ, a division of Standard & Poor's.                                     

Amazon
I read a lot, and couldn't imagine life without Amazon. I bought a few books from my local Barnes & Noble the other day, and as I walked out, I just thought, "Well, that was stupid." They cost twice as much as they would from Amazon. I'm a huge fan of this company. And I realize it isn't just books anymore; Amazon has done a spectacular job plowing into territory once dominated by eBay (Nasdaq: EBAY). I'm bullish on Amazon's future. Big time.

But with a forward P/E well over 50, the company's stock makes me want to gag. Yes, Amazon's moat justifies a premium multiple. But a 50 P/E isn't just a premium multiple. It's a recipe for impending disappointment. Really great companies can blow the doors off earnings while leaving investors behind when shares are bought at sky-high valuations. It's happened before. It'll happen again.

Netflix
I have similar feelings about Netflix. This is a phenomenal company whose future I'm really confident about. I'm one of the many who have said sayonara to cable and now rely almost entirely on Netflix and Hulu for TV entertainment. And I have little doubt that many others will make that shift. Netflix's future is bright.

But there comes a point where a company's success disconnects from its share price. With a P/E ratio approaching 50 and a 225% surge this year alone, I can't help but think Netflix is getting close to that danger zone. Here's what this looks like graphically:

Source: Capital IQ, a division of Standard & Poor's.

More than half of Netflix's return this year is the result of multiple expansion, not earnings growth. That's a dangerous form of return. Netflix is expected to grow 28% per year over the next five years. Does that justify a high multiple? You bet. But a 49 P/E? Sure would make me uncomfortable.

Wynn Resorts
The U.S. consumer isn't dead. Real consumer spending is actually at an all-time high. And thankfully for companies like Wynn Resorts, gamblers in Macau can't empty their wallets fast enough. Wynn has been a remarkable turnaround story from the depths of 2009, sending shares up sevenfold.

But that last fold may have been one too many. Have a look at earnings estimates over the next few years:

Source: Capital IQ, a division of Standard & Poor's.

Say this all goes down as planned, and Wynn earns $4.40 per share in 2014. Now say the company's multiple falls to a far more reasonable -- but still extremely generous -- 30 times earnings. That would put shares at about $132 per share. From today's price of $105, that's a grand return of less than 6% annually. Tweak those assumptions as you wish. It's hard to get excited about a cyclical stock trading with a dot-com bubble multiple.

Sirius XM
I feel I have to join the witness protection program anytime I write critically about Sirius XM. Shareholders are fanatics, and they get fired up when challenged that their Sirius shares aren't rivaling the dollar as the world's next reserve currency.

But I'll take the risk. Here's how I view it: Sirius skirted bankruptcy last year, which is great -- because it came damn close. Then it slashed costs like no one's business -- which is also great, because your average lemonade stand had been more profitable. What's left is a viable company. But what's it worth? That's the issue at hand. Shares trade at 46 times 2011 projected earnings, and 20 times 2012's projected earnings. No thank you. Some counter that Sirius is a cash-flow story. Fine. The company generated $148 million in free cash flow over the past 12 months, which equals a 2.7% yield over its $5.4 billion market cap. Perfectly uninspiring. 

Disagree? I'll go out on a limb and say some of you do. Fire back in the comment section below.

Looking for additional scary stories? We've got what you need in our Halloween special series, Avoid These 8 Investing Horror Shows.