"Risk-on" and risk-off" are remarkably straightforward notions. When investors are bullish, they increasingly migrate into ever-riskier stocks, either ones that sport higher valuations, or ones that are small but potentially quite promising. Yet after a six-month stock market rebound, the "risk-on" trade may be wearing off. And if markets pull back, get ready for the "risk-off" trade (also known as a "flight to quality"), where investors shift funds back into assets that are most likely to preserve capital.
Right now, a number of stocks in the S&P 500 have moved into nosebleed territory in terms of projected 2013 price-to-earnings (P/E) ratios. Here are the 10 most richly-valued stocks in the S&P 500...
In their favor, at least some of these companies can back up their lofty valuations with robust profit growth. For example, Amazon.com (NASDAQ: AMZN), Crown Castle (NYSE: CCI) and Host Hotels (NYSE: HST) are all expected to boost profits at least 25% in 2013.
Yet for many other high P/E stocks, it's simply hard to fathom why investors think they deserve such a large multiple.
I went back and refined the list of the priciest stocks in the S&P 500 by excluding companies that possess robust assets that may not be captured by earnings forecasts -- such as energy plays, insurers and real estate investment trusts (REITS) -- and found 15 stocks that sport 2013 P/E ratios at least 150% higher than their projected earnings growth rates (i.e. a PEG ratio of 1.5 or higher).
Some of these companies are richly valued simply because they have built up an impressive long-term track record. Salesforce.com (NYSE: CRM), Whole Foods Markets (NYSE: WFM) and Chipotle Mexican Grill (NYSE: CMG) have developed cult-like followings among investors, and short-sellers have been battered by trying to bet against them. Still, it's crucial that you constantly re-check your forward growth assumptions for these stocks, as strong growth can't continue forever. If you've ridden these stocks up to huge gains over the last few quarters, then you need to be doubly sure they are still worth holding.
Health care challenges
Any time you see a high-PEG stock in the health care sector, you really need to tread cautiously. Industry cost pressures may make it harder for all players concerned to keep growing. As is the case with likes of Chipotle, salesforce.com or Whole Foods, Intuitive Surgical (Nasdaq: ISRG) is the "must-own" name in health care, thanks to the company's very popular line of surgical spine tools.
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For a number of years, investors have suspected that Intuitive Surgical would make a great acquisition for a larger healthcare company seeking new paths to growth. Yet it would take $25 billion or more to acquire this company at a decent premium, and who has that kind of money lying around?
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More to the point, this is no longer a high-growth company. Gone are the days of 40% to 60% growth. Sales are now on pace to grow at a mid-teens clip, and that may start to lead some key shareholders to cash in profits and seek better opportunities elsewhere. The fact that this stock trades for more than 10 times projected 2012 sales of $2.08 billion is grounds enough to give pause.
Risks to Consider: If stocks move higher still, these stocks are unlikely to be hit by profit-taking and may yet continue to climb.
Action to Take --> Some of the stocks in the tables above have made investors huge profits in recent years. It's hard to part with something that has worked so well, as investors like to "let their winners ride." But cashing out of some of these huge gainers and redeploying funds into lesser-known and cheaper stocks could help extend a portfolio's winning streak. Even a move to cash makes sense in the event these high-flying stocks take a big hit and can be rebought at lower levels.
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StreetAuthority LLC does not hold positions in any securities mentioned in this article.
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