Should You Sell This Garbage Stock?

Up nearly 25% in 2013, Waste Management is now expensive by one important valuation metric.

Jan 9, 2014 at 4:43PM

With the S&P 500 now over 1,800, you may feel compelled to start booking some profits. While many blue-chip dividend stocks are not yet overvalued on a fundamental basis, there are a few stocks that have run up quite a bit. Depending on your time horizon and circumstances, now may be an ideal time to lock in some of those gains -- particularly for Waste Management (NYSE:WM)

This Houston-based municipal provider of waste hauling, recycling and waste-to-energy services is, in management's own words, a free cash flow machine. A favorite among dividend growth investors, Waste Management was nonetheless having trouble maintaining its growth momentum over the last couple of years. 

But over the last couple of quarters, a number of Waste Management's cost-saving initiatives and synergies have put more fire into this company. This includes Waste Management's conversion of its entire fleet to run on liquefied natural gas. While volumes declined in this quarter, price hikes and effective cost management have boosted margins across the board. Yield, which here is defined as revenue from collection, transfer and waste to energy disposal operations, has risen to 2.3% -- three times that of the same quarter last year. 

Rich valuation
All this progress has buoyed the stock price as well. Shares have risen by more than 24.4%. Waste Management now trades at almost 21 times trailing earnings -- by no means cheap.

Looking at Waste Management's average price to earnings, or P/E, ratio over the last 15 years confirms the stock's relative priciness. In fact, Waste Management's average P/E ratio over the past 15 years is 19.1 times. This means that Waste Management is historically overvalued by 9.5%.

While this stock may not yet be grossly overvalued, those who invested for the dividend just a few years ago are now sitting on gains of around 30%. Depending on your situation, you might want to think about collecting some of that windfall now.

Waste Management has proven itself to be great operator over the last couple quarters. It has managed costs very well and has waste collection down to a science. Indeed, margins are steadily rising higher, but waste volumes are now stagnant.

In the long run, Waste Management is a synergy story. Its cash flow and dividends should reaccelerate beyond the meager growth of last year, but it probably won't be anything like the double-digit growth of years past. 

Republic Services (NYSE:RSG), Waste Management's biggest competitor, trades at a more reasonable 18 times trailing earnings, much closer to its average P/E ratio. Analysts also expect to see at least modest growth from Republic. Republic may be a somewhat better value here, but it also has a slightly lower return on assets than Waste Management, as well as slightly lower margins over the last few years. 

Bottom line
Regardless of where Republic stands, in my opinion Waste Management is moderately overvalued, and no longer the high-growth story it was years ago. If you were in the stock primarily for dividends, but are now sitting on outsized capital gains, you might want to think about whether Waste Management still merits a place in your portfolio. 

Casey Hoerth has no position in any stocks mentioned. The Motley Fool recommends Waste Management. The Motley Fool owns shares of Waste Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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