In the last newsletter article, we showed the pricey valuation of Apple. Instead of just picking on Tech, I thought it might be helpful to look at a few old-fashioned retailers, as the bubble is pretty widespread.
Walmart trades at 38x earnings.
Costco trades at 56x earnings.
To put some context into this, if Costco were to grow its earnings by 10% per annum over the next decade, but the stock stayed flat, the P/E ratio in year 10 would still be around 24, which is actually higher than it has traded in many periods historically.
The logical question is why are these stocks trading so expensively? I think the answer lies mostly on the impact of passive index investing. When money flows into index funds, they buy the stocks irrespective of valuations. The biggest companies get the biggest flows of capital. It’s a major tailwind, but the reality is that you are getting less earnings and cash flow for your investment dollars. Like any bubble, it works until it doesn’t. You can imagine a scenario where fear grips the market and the money begins flowing out of these indices, which would result in the most money coming out of the largest companies, reversing the cycle. This seems like a very dangerous cocktail to this investor, so while optimism is the highest it has been in decades that stock returns will continue to be strong, I’d take the other side of that bet.
Let’s contrast these multiples with some other stocks in more out of favor industries.
Crown Castle owns cell phone towers across the United States. Thes stock pays a dividend yield of 6.34% and trades at 14.09x AFFO, versus a normalized price/AFFO of 20.53. This is the equivalent to P/E ratio for real estate stocks.
WP Carey owns mostly industrial real estate and pays a 6.27% dividend and trades at 11.88x AFFO, versus a normalized multiple of 13.6x.
BNPQY pays a 6.77% dividend yield, with a 16.61% earnings yield.
Devon Energy pays a 3.6% dividend and trades at 7.3x earnings versus a normalized multiple of 13.48.
BHP pays a 5.51% dividend yield and trades at 10.41x earnings, versus a normalized multiple of 13.13x.
All five of the companies that I listed have real assets, such as real estate, oil/natural gas, of metals such as copper, nickel, etc. These are not industries that are going to see demand collapse by any stretch of the imagination in the near future. While they don’t get the same tailwind from being the largest components in the S&P 500 like a company such as Apple may get, I’d bet that they will outperform Apple over the next decade, with less risk too.