Flashing Red: The Dow's 3 Most Expensive Stocks

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

This year is almost in the books, and the stock market will finish 2013 strong. On the morning of the last trading day of the year, stocks are at a record high, with the S&P 500 up 0.21% and the narrower Dow Jones Industrial Average (DJINDICES: ^DJI  )  up 0.20% at 10:15 a.m. EST.

The stock market has had a banner year -- its best since 1997. As of Monday's close, the Dow is up 25.9%. (The return is 29.1% once you account for dividends.) Naturally, that rise has been accompanied by increasingly frequent warnings that stocks have become overpriced. Below I take a brief look at that charge with regard to the Dow's three most expensive stocks (on the basis of price-to-forward earnings multiples): Visa (NYSE: V  ) , Nike (NYSE: NKE  ) and Boeing (NYSE: BA  ) .

 

Price-to-earnings multiple*

Year-to-date price return*

Visa

24.6

46%

Nike

24.3

53%

Boeing

19.2

80%

*At Dec. 30. The P/E multiple is based on next twelve months' earnings-per-share estimates. Source: S&P Capital IQ.

Two of the three stocks, Visa and Nike, only joined the Dow in September. Visa replaced Hewlett-Packard and Nike replaced Alcoa. As globally recognized names with durable franchises, both are worthy additions to the venerable (if anachronistic) index. Nike has built a global brand around sports shoes, apparel. and equipment. Visa's franchise is even better entrenched, drawing on two types of competitive advantage: a global brand and the world's largest retail electronics network. These are the type of businesses that can support a premium valuation -- and make no mistake about it, these stocks do trade at a premium to the market (the S&P 500 is currently valued at roughly 16 times forward earnings). The question is, what is a fair premium?

All three stocks (particularly Boeing) have easily beaten the S&P 500 and the Dow in a roaring bull market. That feat may raise suspicions that investor exuberance is the culprit, but it is not simply the product of investors willing to pay a higher multiple to own these shares. In the case of Visa and Boeing, multiple expansion accounts for less than 40% of this year's rise in the stock price; the rest is due to increases in earnings (estimates). In the case of Nike, however, the increase in the multiple explains two-thirds of this year's return.

Bottom line: None of these stocks look particularly attractive right now, but if I had to rank them in descending order of attractiveness, it would be Visa first, then Boeing, and finally Nike. Visa's wide moat, capital-light business model, and growth prospects are worth the highest multiple -- certainly higher than Nike. Meanwhile, Boeing is the better of two companies operating a duopoly. If you own any of these three stocks, there is no cause for panic, particularly if you are (as I recommend) a long-term investor. But don't go thinking you will earn the same returns in 2014 that you earned this year, because that simply isn't going to happen.

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