Just Because the Price is High Doesn’t Mean the Stock is Expensive

Alan Brochstein Screens for Stocks Approaching $100

This week, a lot of attention has been paid to a milestone on the NASDAQ. A well-known company’s stock has surged to $500 a share for the first time ever. This is a unique company that has created its own market that we could only have imagined several years ago. I bet you think I am talking about Apple (AAPL), and, of course, I am, but I could just as easily be referring to Intuitive Surgical (ISRG), which I wrote about a year ago when it was just $260 per share. Stock splits sure seem to be losing their popularity!

In the olden days, companies would almost always split their stock (increase the number of shares outstanding and lower the trading price accordingly), but there was a good reason: It was more difficult to buy fewer than 100 shares (an “odd-lot”). In fact, there was even an “odd-lot charge”. Companies, then, in order to appeal to a broader universe of investors, believed that a lower price per share would perhaps increase the total value of the company or at least improve the liquidity. These days, for a very low flat fee, an investor can buy a lot of stock. The commissions are so low that they are almost irrelevant to the long-run success of an investment.

Now, if you have ever eaten a pizza, you probably know that no matter how you slice a 12-inch pie, it’s still a 12-inch pie. You won’t get any fuller eating 8 slices than you will by eating 6! The same is true for the total value of a company. A company with 10mm shares trading at $100 is worth $1 billion, just like a company with 50mm shares trading at $20.

In the S&P 500, 44 companies (about 9%) trade above $100 per share. I mentioned two that trade above $500, but there are two that trade even higher: Google (GOOG), which I wrote about in December, and Priceline (PCLN). I am often amazed by how challenged some investors are when discussing these high-priced stocks. A $800 target on a $600 stock seems “outrageous” to some, while they might not think twice about a $80 target on a $60 stock. Do they not understand the pie analogy?

I believe that investors think that they have a better chance of seeing a $2 stock run to $3 than a $200 stock run to $300, but the chances might actually be lower. Why is that? There is a reason a stock gets to $200, and there is a reason a stock gets to $2. While it’s no guarantee, momentum often persists for long periods of time. For the company trading at a high price, they just need to keep doing the things that have brought them success before. It’s true that this doesn’t always happen, but it seems a lot easier than what the low-priced companies need to do: Reverse the problems.

When I look at a stock, I don’t pay too much attention to the price, focusing instead on the market cap (number of shares times the price). To me, AAPL may be $500, but it’s really $466 billion. I try to tie this value to the fundamentals of the business, like earnings. Imagine if you owned AAPL but sold it at $200 just because the price seemed “high”. The smartest thing you can do is to focus on the value rather than the price: A $200 stock can be very inexpensive, and a $2 stock can be extremely overpriced.

One odd thing I have noticed over the years is that stocks tend to stall as they approach a “century” level, like $100. I think that it makes sense that there is some natural resistance, with $99 sounding a lot cheaper than $101, even if it’s the same 2% difference as that between $9.90 and $10.10. Often, this quirk can create a great entry. I have been watching closely a stock on my watchlist that seems to be stalled near $100 – Middleby (MIDD). I can’t predict when it will get through 100, and it might not ever do so, but I can make the case that it perhaps already should (we’ll leave that for another day).

With this in mind, I wanted to share a quick screen designed to highlight some potential opportunities. Here are the parameters I used:

? > $500mm market cap

? Stock price > $90 but < $100

? Within 4% of its 52-week high

? 5-year High < $100

? EPS Growth (last 4 quarters) > 10%

Here are the five that made the cut:

Keep in mind that these are not recommendations. You should do your own thorough investigation of any investment you make.

I sorted the list by economic sector, and we have choices in three different ones. I included a few other columns, including the 52-week and 5-year price ranges, the return over the past year (only one is up sharply), the forward PE (all below 20X), the average PE over the past 5 years (none extremely above the average) and projected earnings growth for 2012.

So, hopefully I have given you a few ideas to ponder and maybe some stocks to consider as well. Yes, the idea is to “buy low and sell high”, but sometimes a stock with a high price can have a low (or at least reasonable) value. Through our screen, we were able to find some stocks that are approaching the $100 psychological level. Remember, screening is only a first step. Before investing, you should do your own investigation to identify risks and potential opportunities.

Regards,

Alan Brochstein Founder, Invest By Model and AB Analytical Services TradeKing All-Star Commentator

Disclosure: GOOG is in the Top 20 Model Portfolio at Invest By Model

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