"Disruptive" can be an overused term in investing, but if you find a company with a strong competitive advantage and a large market opportunity, a high price tag shouldn't scare you away. Many investors miss out on large gains because such stocks often look expensive, but if you hold a diversified portfolio, you shouldn't be afraid to pay up for special companies, which, by definition, are rare.
In that light, here are three stocks that have high price-to-earnings ratios -- but deserve them based on their disruptive potential.
Generational shifts can compensate for high valuations. Image source: Getty Images.
Amazon
You might think a $560 billion company would be out of growth opportunities, and 99.9% of the time, you'd be right; however, Amazon (AMZN +0.61%) is no normal company. While the 338 price-to-earnings ratio may scare some, the Jeff Bezos–led company is currently disrupting three massive markets -- retail, streaming video, and IT services. As such, the company is spending all that it can on fulfillment centers, data centers, and big-budget shows to establish leading positions.
Amazon now has roughly 44% of the e-commerce market, up from 38% in 2016, and e-commerce itself grew roughly 13% in 2017. E-commerce is only about 13% of U.S. retail, according to Forrester, which means Amazon has plenty of room to grow even further, domestically and internationally. Its Prime service and Alexa voice-enabled speakers are becoming increasingly embedded in the modern smart home, which should spur increased purchases from Amazon's e-commerce platform.
In addition, Amazon's Web Services (AWS) division has a huge lead in the cloud computing business, also a massive growth market. Amazon's head start has given its AWS platform a huge 44% market share, according to Gartner, and revenue from the segment was still growing over 42% last quarter. At the company's recent Re: Invent conference, AWS unveiled a dizzying array of new advanced features and services like this one, which should keep AWS ahead of the competition and growing for years to come.
And by the way, Amazon has also been rumored to be eyeing the pharmacy industry -- just another hundred billion dollar opportunity. Ho-hum.
Netflix
One area where Amazon is actually trying to catch up is streaming television -- where Netflix (NFLX +0.13%) currently dominates. Even if Amazon succeeds, most households have multiple streaming services, and Netflix is almost surely the primary one. Netflix has been truly disruptive to the entertainment industry, as you can see:
NFLX 3 Year Total Returns (Daily) data by YCharts
How did Netflix do it? The company initially licensed older shows and movies from its competitors on its low-priced platform. As Netflix grew subscribers, it could afford higher-quality content, and eventually started making its own shows, landing massive hits like House of Cards and Stranger Things. That led to more subscribers, and, in turn, expansion to over 190 countries.
And Netflix isn't slowing down, forecasting $8 billion in content spending in 2018, up from $6 billion this year and far more than rivals. While this heavy spending has depressed Netflix's earnings -- the company currently trades at a dizzying 223 times earnings -- as long as subscribers and engagement continue growing, Netflix will benefit. The company's top creative talent is producing stellar content which has attracted to Netflix's more than 100 million subscribers. That's how the company lured hitmaker Shonda Rimes from ABC last year, among others. Hit shows should allow Netflix to keep growing and raise prices, which should eventually lead to much higher earnings.
National Beverage
One disruptive company you might not know is National Beverage (FIZZ 0.29%). National Beverage doesn't have the dominance or ubiquity of Amazon or Netflix, but its LaCroix sparkling-water brand has a chance to upend the giant soda industry. As a new generation turns away from sugary sodas that dominated the past century, LaCroix is really taking off in a health-conscious world.
National Beverage trades at a lofty 37 times price-to-earnings ratio but backs it up with 20.8% revenue and 38% earnings growth last quarter. But even that masks the growth rate of LaCroix, which is only one brand in a larger portfolio that includes lower-growth brands like Shasta, Faygo, and Everfresh. National Beverage lumps LaCroix in with its Power+ Brands -- that segment grew at a 41% clip last quarter, but LaCroix's growth was likely even higher than that.
While some think LaCroix may easily be duplicated by others, I'm not so sure. Much of the soda industry is built on marketing, and LaCroix's cult status, mindshare, and variety of flavors should keep it growing for years.
Disruptive companies are often hotly debated and subject to volatility, but for long-term investors, these companies are names you shouldn't ignore -- even at these levels.
