Investing strategies come and go but few metrics have stood the test of time the way that analyzing price to earnings ratios has. Long a hallmark of value investing, companies with a low price to earnings ratio have been sought after for years by anyone seeking a possible deal in the stock market. This is because many assume that they are getting a better value, paying less for every dollar of earnings than their higher PE brethren, making these companies ideal choices for value investors.
While looking at PE ratios obviously shouldn’t be the only thing that investors consider before buying a stock, it is often one of the first and is an easy way to get basic information about how a company is performing and is expected to do in the near future.
Yet while many investors focus in on low PE stocks, many forget about those on the other end of the spectrum, those with ultra-high PEs. It is true that a high price to earnings ratio can signal robust levels of growth when it is in the mid-20s or even into the fifties, but what about when this key ratio is even higher? Specifically, what about companies that have trailing-twelve-month PEs north of 100?
Whether companies can ever live up the hype that comes with such astronomical PE ratios is an impossible question to answer, especially in this low growth environment stretching across much of the developed world. Yet with significant earnings growth, these companies could push this ratio down and handsomely reward investors who were bold enough to stick through this seemingly difficult situation.
For investors looking to put some of these firms under the microscope, I have highlighted four companies in the relatively fast growing business software and services segment of the tech industry that all have PEs well over 100 and in some cases, exceeding nearly three times that figure as well.
While it remains to be seen if these companies can live up to the hype, one thing is for sure; they all have their work cut out for them in terms of earnings or are due for a massive fall in stock price in order to get their key PE ratios in line with industry counterparts.
Aspen Technology (AZPN)
Aspen is a Massachusetts-based tech firm that provides software for manufacturers as well as engineering and construction firms. The company has seen shares surge over last 52 weeks, gaining nearly 75%, but the firm still only has earnings of roughly nine cents a share, giving it a PE ratio approaching 188. Fortunately for the firm, demand for software in their key market segments looks to grow; the company estimates growth of 12% annually through 2013 for manufacturing optimization software and 10% annually though 2015 for the engineering market.
With that being said, the industry is relatively high in competition and other market participants could steal share from AZPN in the years to come, especially giants like Honeywell (HON), Siemens (SI), or Oracle (ORCL). Furthermore, both top and bottom line growth has been pretty much none-existent over the past half decade as gross profit was roughly $247 million in 2007 and was just $145 million for the fiscal year ending June 2011.
Part of this change could be due to a shift to a subscription based model for the firm’s key services; this spreads out the revenues more evenly, rather than the ‘up-front’ style that the company had previously had. This may be part of the reason why the PE for this firm is so out of whack, especially compared to its peers. Another potentially positive item is the company’s ‘future cash collections’ which amount to nearly $791 million at the latest fiscal year end. Thanks to this nice stream of cash and shift to the subscription model, a closer look at this company is definitely warranted before dismissing it over the PE ratio alone.
Iron Mountain (IRM)
Iron Mountain is another Massachusetts-based company, but unlike its software-focused counterpart, IRM helps to manage information and files for its clients. The firm assists customers in organization, maintenance, and storage of paper records along with a host of auxiliary services as well. IRM has also had a pretty good 52 week period, gaining over 50% in the time frame. The company also pays out a surprisingly robust yield of just under 3.2%, making it a potential play for those seeking more current income. However, investors should also note that the company has an extremely high PE ratio, close to 320.
Unfortunately for this company with an ultra-high PE, growth has been extremely hard to come-by. Revenues are only up 3.8% when comparing the previous two fiscal years and operating expenses are up 13.8% in the same time frame. This suggests that it is becoming increasingly difficult for IRM to keep profits margins high in light of extensive competition.
In fact, IRM swung to a loss for the most recent year, the first time since 2008 that the company was in the red. Given the razor thin profit margin and the increasingly competitive landscape, one has to wonder if Iron Mountain can live up to its lofty PE in the near term or if a crash in stock price is due for this recently unprofitable company.
Pegasystems is a small firm that develops, markets, and licenses software to help businesses automate a variety of tasks. The firm operates primarily in the U.S. and Europe and has a variety of partnerships with major companies such as Accenture, Cognizant technology, IBM, and PwC. These alliances help the company sell its products to a variety of end users in the financial, health care, and insurance industries. The past 52 weeks have been pretty good for PEGA as the company has gained close to 84% although there has been some significant volatility in the mean time.
In fact, when looking at the 2011 period alone, the company is up just under 10% suggesting that most of the gains from earlier in the 52 week period were wiped out. Furthermore, investors should note that the company is sporting a truly impressive P/E ratio, approaching 280 for the trailing twelve months, suggesting that some investors are expecting truly robust growth in the near term.
When looking at recent financials for PEGA, an interesting trend appears. The company has seen revenues surge by close to 27% over the previous year but gross profit is up just 20% in comparison. Further to this point, operating expenses have grown by close to 60% in year-over-year terms, suggesting that PEGA is becoming less efficient at turning revenues into profits, a troubling situation for investors.
Even more troubling is that a large part of the revenue increase of 2010 was the result of an increase in ‘maintenance’ revenue as opposed to the licensing or the professional services segments, suggesting that reoccurring revenue may not be in the firm’s future. Thanks to these cost headwinds and the firm’s inability to keep gross profits at a steady level, one has to wonder if PEGA can live up to the hype that comes with such a lofty PE or if it is due for a further crash in share price in the near term.
Qlik Technologies (QLIK)
With the highest P/E ratio of the companies on the list, Qlik certainly has its work cut out for itself in order to grow back into a reasonable PE ratio. In fact, the company currently has an astronomical PE of just over 500, by far the highest on this list. QLIK develops a range of software products in the data analysis and reporting fields, primarily for customers in both America and Europe. In terms of end users, customers tend to be in the consumer goods, financial services, health care, and tech sectors.
Like many of the firms on this list, Qlik Technologies has seen its share price surge over the past 52 weeks, accelerating by close to 33% in the time frame. However, the stock has fallen by close to 23% in the past quarter alone, suggesting that headwinds may be building against this Pennsylvania-firm.
Fortunately for QLIK, the firm has seen a tremendous rate of growth over the past few years, and especially so in the license revenue segment which is their biggest driver of revenues. In fact, revenues have grown by over 500% in the past five fiscal years in the licensing segment which has led to a similar increase in gross profit over the same time period.
Further to this point, the company has seen earnings rise from just one cent a share in 2008 all the way up to 21 cents a share in the previous fiscal year, suggesting that the company may have the ability to match the lofty predictions that investors have set for QLIK and that the recent drop in stock price is somewhat unwarranted for those with a long-term focus. It also helps that the profit margin is extremely high for the company and that more growth in revenues hasn’t translated to higher costs for the most part.
This means that despite having by far the highest P/E ratio, QLIK has one of the best chances to grow into a solid firm with an impressive growth rate, so long as it can keep up recent trends into the future.