Five Great Quality Companies: Are They Too Expensive?

by: Larry Bellehumeur

I'm the first one to like to pay for value.....I like the extra thick hardwood floors that my wife and I had installed. They cost more, but they give a great feel and add value to the house. Same for the fact that I spent more for my Mercedes than for a lesser priced car, as I see the value in quality.

However, at what point does "quality" just become too expensive?

These 5 companies are great companies, but is a great company still great when it is overly expensive? It is, but it makes it a bad stock …All of these stocks are worth buying at better evaluations….

1) Monsanto (NYSE:MON)

Yes, this truly is a great company, and agriculture is a great place to be. So what is the problem? For one, the company is trading at 33x expected 2008 earnings, and about 26x 2009 projected earnings, in what is supposed to be a down market. This price means that this one can't disappoint at all, or else it will see some serious multiple contraction.

With an expected growth rate of 28% (that does seem high to me, so I would likely lower it down to 22x 2008 earnings to provide more of a margin of safety -- yes, I've been to Omaha, and drank Buffett's Kool-Aid), this means that a more suitable price may be in the $75 to $80 range, a far drop from its current price north of $115.

(FYI – I'm sure to see comments on this one, which I welcome. I know Monsanto well, as I have done some work with both this company and one of its main competitors, Syngenta. Syngenta (NYSEMKT:SYN) trades at a more reasonable 19x 2008 earnings, by the way)

2) Google (NASDAQ:GOOG)

First off, I love Google. I used many of its products all of the time, and think that it has a world-class brand. It likely will do well in all areas that it ventures into.

My love ends when I try to get my head around the evaluation of its stock. Most of its revenue still comes in the form of search and its various ways to get revenue (ad-clicking, search order placement, etc). Last time I checked, everyone else who is tied to the consumer has seen their stock severely trounced. While Google has corrected from its ridiculous high of over $745 last fall, it still trades at 29x 2008 earnings.

The market is calling for a 20-25% earnings growth from Google (which I think might still be on the high side, considering the environment that we are in). I suspect that we'll see earnings revisions falling if the economy does not turn around a bit faster. I still like Google better than most of the S&P, so I don't mind giving it an evaluation higher than most.

With a 20x 2008 earnings multiple, and an expected earnings of $16.25 in 2008, I would peg Google's value at a more trim $325US (which is well short of its price of close to $500US now).

3) Apple (NASDAQ:AAPL)

With all due respect to Steve Jobs, whom in my humble opinion, is the premier CEO in all of business, this one smells expensive. Sure, the company is firing on all cylinders - iPods are still all the rage, everyone wants a new 3G iPhone, and Mac has really started to heat up its marketshare against Microsoft (NASDAQ:MSFT). So, how can such a company with these growth characteristics be overvalued?

First, its recent low guidance doesn't scare me. It always guides low, so why should it change now? What scares me is the fact that this stock is now priced as if there is little chance that anything can derail its success. While Apple is brilliant in its ability to remember that consumers buy electronics as consumers and not as engineers (so, coolness helps). However, consumers are notoriously fickle (anyone still own Crocs (NASDAQ:CROX) stock?). While it has a great brand name, and a great pulse on the consumer, is this enough of a sustainable competitive advantage to justify its evaluation? Also, while everyone seems to find money for Apple's toys, regardless of the state of the economy, I suspect that things might be a bit worse before they get better, so even toys such as iPods become discretionary at some point.

Like Google, I would still recommend giving Apple a superior evaluation to the overall S&P. I'd even be willing to give it a higher P/E than Google, so I would say 22x 2008 earnings is fair. This would give the company a fair value of $114. Apple did get down to close to that price, so I did buy Apple at $120 or so earlier this year, but I sold it at $180 a while back.

4) Mastercard (NYSE:MA)

Mastercard is the kind of stock that you can buy and hold until your retirement, regardless of how old you are….yes, it is that good. It has great exposure to many key areas. First, it is a great way to play to strong movement away from cash to credit. Second, it has a network that would be quite hard to develop from scratch, and its main competitors (Visa (NYSE:V) and AmEx (NYSE:AXP)) are all growing well. Finally, it provides strong exposure to International markets. And, to boot, it has no exposure to credit losses (see Amex), as those are handled by the banks.

So, why does it make this list? Everyone believes that the consumer is hurting right now, and many large purchases get put off. When it costs more to put gas in your tank and to buy groceries, discretionary spending gets hit. While people still may use their M/C for gas and food, more people use it for clothes, household items, etc, and these may see a dip in the next year or so.

At 29x 2008 earnings, this one isn't factoring in the consumer spending slowdown. Again, buy MA for the long run, just not at these prices. I would think that it warrants an Apple-like P/E, based on its merits. Using a 22x 2008 earnings ratio, this one should trade more in the $195 range (down from its north of $250 price now).

5) Research in Motion (RIMM)

Being that this is a great Canadian success story, and that I am a proud Canuck, this one is painful for me to add. This one has always seemed overvalued, but has been an absolute gem of a performer over the past few years. Does anyone not know the Blackberry brand? Is there anyone at the airport not typing on one? RIM is an absolute dominant player in this space, and does have a great moat around its business (ok, last Buffett term, I promise). However, that is where the praise ends.

RIM is a very volatile name, as people seem to always want to find a reason to chop its P/E down. Whether it is a threat from Apple, patent challenges or exposure to the Financial sector, everyone has a reason from RIM to fall.

Whlle I think that all of those things are well known, they aren't reasons not to buy RIM. Its evaluation may be, though. At 31x Feburary 2009 earnings, this one is priced for perfection. I think that there will be some weakness in the economy, and even RIM won't be able to escape it. This one is a great long-term hold, though, so look for it at a lower price.

I would give RIM a rich 24x current year evaluation, my highest of the five. Based on an expected earnings of $3.65 (I'm knocking it down from the consensus), it would be a screaming buy when it is south of $90.