Can a Company With Attractive Results Be an Ugly Stock?

To answer the question in the headline, it is not uncommon. It happens when the shares become so popular and have run so far that future returns are very likely to be terrible. Even the best companies can become so overpriced that there is little to no chance of making positive returns over anything but the shortest duration holding periods. Cosmetics manufacturer Estee Lauder is a prime example. Since 2012, EL's sales, cash flow and earnings per share have all doubled or tripled. The annual dividend rate more than quadrupled. Those are great stats. However, they need to be compared with the stock's movement in relation to the value created. For Estee Lauder, the shares far outpaced that fine growth. By definition, that can only happen due to multiple expansion. Estee Lauder fetched a relatively normal 26x earnings on Dec. 3, 2012. Exactly a decade later, they commanded 45.3x fiscal 2022 earnings estimates (EL's fiscal year ends June 30, 2022). From 2011 through the last pre-COVID year (fiscal 2019), EL shares averaged 25.8x earnings, accompanied by about 1.22% in current yield. As of last Friday, Dec. 3, Estee Lauder's price-to-earnings (P/E) multiple was greater than 75% above normal while the yield was 41% below average. The four times Estee Lauder carried multiples of higher than 32x (red-starred below) all turned out to be horrible times to own the stock. EL fell from $97.50 to $75.30 in under eight months back in 2016. It dropped from $158.80 to $121.50 in short order from mid-year 2018 to January 2019. When COVID struck in 2020, EL slid quickly from almost $220 to $137, down nearly 38%. This year's peak of $357.82 came just a few months ago. As of last week Estee Lauder had declined to $335.30. All those selloffs, excluding 2020, came as the company was posting record profits. Due to its stellar track record Estee Lauder never sells cheap. Its seven best buying opportunities (green-starred above) ran from 20.8x to 25x current-year earnings per share. Buying Estee Lauder in that valuation range has always proved profitable. Why pay through the nose to get into EL now, when you're very likely to get another chance to buy at a much better valuation? If you already own it, why not sell before the next major decline? Independent research from Morningstar labels Estee Lauder as a 2-star, out of 5, sell. Morningstar cites as reasons EL's high P/E, low yield and extraordinarily extended price-to-sales ratio. It puts present-day fair value for EL at $271. That figure implies more than 19% of downside risk even if the stock continues to hold at a 36.6x P/E. Despite a record year of results, Estee Lauder shares have gone relatively flat since hitting almost $334 last July. There is less than 1% short interest, so no squeeze potential is going to come from that modest figure. Value Line's three- to five-year price range projections tell you all you need to know about Estee Lauder's longer-term share price prospects. Value Line assumes a 30x multiple is sustainable, even though that is almost 20% above EL's historical average. Even so, projected 2024 through 2026 EPS of $9.00 only figure to keep the stock between $230 and $310. Where's the upside from $335.30? It's close to nonexistent due to the ultra-high current valuation. Market historians remember how long it took tech/Internet stocks to get back to their old 1999 peaks after the bubble burst. Companies such as Microsoft , Oracle and Cisco Systems took 15 to 17 years to recoup those crazy levels. We all have limited amounts of investment capital. Don't get caught holding the bag on shares that have high probabilities of going down, or nowhere, over long periods of time. Love Estee Lauder's products but avoid its shares until they get back to a more realistic level. Much better choices abound right now. (EL is a holding of Action Alerts PLUS. Want to be alerted before the portfolio buys or sells these stocks? Learn more now.)

Can a Company With Attractive Results Be an Ugly Stock?

The short answer is yes, as the shares of cosmetics maker Estee Lauder have shown over the years when they've become overvalued.

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