5 Overheating Stocks Ready for a Sharp Pullback

by: Vatalyst

I took a look at five companies whose shares shave been outperforming lately, and whose shares may be reaching a point where a sharp reversal is overdue. I have concentrated on the PE ratio for this analysis. In basic terms, the PE ratio tells how many years an investor would need to hold the stock in order to recoup his investment, if the company made a level income and that income were wholly returned to shareholders. The following are the companies that I believe are overheating and ready for a sharp pullback:

Netflix (NASDAQ:NFLX): Netflix offers subscribers a library of movie, television, and other filmed entertainment on DVD. Members have DVDs delivered to their homes, or may watch content streamed instantly toTVs and PCs. Founded in 1997, it is headquartered in Los Gatos, California. Its shares trade at $276.58 on the day of writing, about 9% below the 52 week high of $304.79, but up very strongly from the 52 week low of $95.33. Last year's EPS of $3.48 put the shares on an historic PE of 79.43. If analysts' forecasts of 2012 EPS of $6.65 come to fruition, shares are trading on a prospective forward PE of 41.59. Any undershoot of this optimistic forecast would be damaging to the shares. The company pays no dividend, and is a pure play on the continuing appetite of its members for DVD products. For a company with one stable product and no dividend – nor hopes of one – to offer longer term support for the share price, the current and forward PE ratios look optimistic, to say the least.

Amazon Inc. (AMZN): Amazon was founded in 1994 and is based in Seattle, Washington. It operates as an online retailer around the world. It focuses on selection, price and convenience, and offers programs that enable sellers to use its web sites as well as their own branded sites. It also manufactures and sells the Kindle e-book, and publishes traditional and e books through subsidiaries. The share price of $216.52 on the day of writing, near its 52 week high of $220.20, is more than double its 52-week low of $105.80. Capitalized at $97.88 billion, its shares trade at a PE multiple of 93.77. Revenue is expected to rise dramatically in the coming 18 months to $60.76 billion, and EPS are set to move up to $3.80. However, even if these numbers do increase like this, the forward PE ratio will still be above 60. Perhaps this is why the median 12 month price target is $214.85, with the most bearish analysts going for a target of $120. Even if the shares fell to this level and earnings rose as expected, the PE ratio would still be a lofty 31.57. At the current PE ratio of 93.77, shares seem overbought and overvalued. Competitively, Barnes & Noble (NYSE:BKS) is not a significant threat to Amazon's position.

Baidu Inc (BIDU): Baidu Inc provides Chinese and Japanese language Internet search services, and offers online community based products and entertainment platforms. It also designs and delivers online marketing services, which it sells directly and through its distribution network. The company was founded as Baidu.com, Inc., and changed its name To Baidu in 2008. It is headquartered in Beijing, China. The company pays no dividend, and its shares trade at $154, near its 52 week high of $156.04. This values the company at a staggering $53.72 billion. With its EPS at $1.82, Baidu-- that has revenue of approximately $2.01 billion-- has a PE ratio of 84. With EPS expected to rise to $4 through 2012, the forward PE ratio stands a lofty 38.5. In other words, the market values Baidu Inc more highly than Amazon on a forward-looking basis. Shares look top-heavy with this high PE. Additionally, competitive pressures from Google (NASDAQ:GOOG) and Yahoo! (YHOO) may mount as these companies assert themselves in east Asia.

LinkedIn Corporation (LNKD): The operator of an online professional network, LinkedIn was founded in 2002 and is headquartered in Mountain View, California. The company allows members to create, manage, and share their professional identity, building relationships and engaging with a professional network. This is a Facebook for "suits." To date, it has not paid a dividend, and next year’s anticipated EPS of -$0.06 will not allow it to start paying one. The following year though, EPS is expected to rise to $0.32. The PE ratio, using the latest fiscal reported earnings of 0.09 per share, is a gravity-defying 1183.56. This is higher than the ratio at which Yahoo traded just before the last tech bubble burst. The company is valued at $9.73 billion, and shares are trading at $102.97 on the day of writing. The 52-week high is $122.70, and the low is $60.14. Even if the estimated forward EPS of $0.32 for fiscal 2012 is reached, the shares (at today’s price) will be trading on a PE ratio of 321.78. Heady stuff, indeed, for a company whose current year revenues are estimated to be $471.18 million, and which has no track record of rewarding shareholders through dividend payments. Perhaps this is why analysts' 12 month share price targets center around $79.57. We agree with them.

New Oriental Education (EDU): Operating primarily in China, New Oriental Education provides private educational services. Its services consist mostly of language training, primarily English, and other foreign languages. It offers test preparation for language and entrance examinations used by educational institutions in the United States. New Oriental was founded in 1993, and is headquartered in Beijing, China. Analysts expect EPS to nearly double from last year’s $2.37 to $4.55 the year after next, which is probably why the shares are valued with a PE multiple of 54. With no dividend and an industry average PE of 18.05, New Oriental Education shares look heavy at their current price of $127.71. A retreat to the 12 month low of $86.82 would still see them valued at a PE of 36.6, double the industry average and reliant on very bullish earnings targets. I question whether these targets can be met.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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