Weep for the Earnings Growers, Too

 | May 22, 2014 | 7:14 AM EDT
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This market doesn't just struggle with how to value the pure growth vehicles that are sacrificing near-term profitability for hope for riches down the road.

It also doesn't know how to value high-growth companies that have solid earnings per share but trade at very rich multiples to those earnings.

You can see the market's teeth gnash at a stock like Starbucks (SBUX), which sells at 26x earnings. So many things have to go right just to maintain that multiple, as this market is in no mood whatsoever for multiple expansion. That's what has felled so many stocks since the end of February. The market seems to be saying that Starbucks, down 10% for the year and 12 points from its high, simply is no bargain.

Now, this is a severe judgment, because Starbucks is very much hitting in on all cylinders: Its U.S. business is booming; its China operations are on fire; India's coming on strong; Europe's gotten good again; and the rollout of everything from new food to wine and beer seems to be going fantastically. Plus there's Teavana's Oprah Chai Tea -- which, from early word, is working magic. There's also the electronics-payment business, which is the envy of every other retailer on earth.

But isn't that why Starbucks is at 26x earnings? Unless earnings are about to take a dramatic step function upward, you aren't going to see this stock go back to those highs. As great as the company is, I don't know if that's a possibility. Accelerating revenue growth is difficult for a company of this size. I think the judgment is that you hold on to the stock and wait. New people? Wait until it trades at a level that's not as lofty vs. the S&P 500's 17x. I just don't know if Starbucks will get there.

Still, though, there's no hurry. There's no hurry with Whole Foods (WFM) either. Here's a best-of-breed operator that has distinctly fallen on hard times, even as Whole Foods' hard times would be good times for just about any other retailer. The comparable-store numbers have been shading down -- and that would be acceptable except that the stock, even as it has fallen from $65 to $37, is still not cheap, selling at 25x a diminishing 2014 earnings estimate. With Starbucks, the odds favor an estimate beat. With Whole Foods, the odds now favor an estimate cut. So it's just a moving target to the downside, as the market will never award even a best-of-breed player an increasing multiple when there is a suspicion of slowing earnings growth.

Nike (NKE) is in the same boat. Right now the stock sells a 25x this year's earnings. That's on the high side, given the firm's long-term 13% growth rate. I think Nike's got a terrific chance of beating estimates. But I thought that last quarter, as well, when the stock was at $80 and the company disappointed not on earnings but on outlook. I think the outlook can be beaten but, with that lofty multiple, it's not clear that the stock is living on easy street.

As tough as it is to value Nike, consider the curious case of the 50x earnings Under Armour (UA). Here is one of the great growers of our time, one that beat earnings and sales goals and then raised them for the future. What happened? The stock got knocked hard, and it's still trying to recover its footing. You have a multiyear growth path that could go on for as far as the eye can see. Yet the stock is stuck in purgatory, because no one knows what to pay for the fastest-growing apparel company.

Finally there's a new kid on the block: GrubHub (GRUB). Here's a company that sells a 72x earnings that's growing like a weed. Its take-out delivery business is expanding rapidly. It takes 13% of every transaction and its building up restaurant-customer communities all over the U.S. and in Europe. It's really the only credible player in the industry. But 72x earnings for perhaps the fastest-growing profitable company right now? I just don't think the market will swallow it.

So don't weep just for the pure sales-growth companies. The market is snubbing its nose at terrific earnings-growth stories, too. The search for value is off with these companies. The search for price -- now, that's another story.

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