Recently the Australian Financial Review reported comments by local fund managers regarding the pricing of some of the ASX's most popular stocks. Two of the stocks singled out by the 'fundies' were REA Group Limited (ASX: REA) and Carsales.com Limited (ASX: CRZ). Both of these companies have enjoyed spectacular rises in their share prices over the past year. REA's share price has soared around 87% and Carsales.com has jumped 25%. Earnings growth has been impressive at these firms, however the consensus amongst these fund managers was that with REA and Carsales.com trading on forward multiples of 42.6x and 28.4x respectively, there is little room for further gains.
With the wider market trading on an average of 14.9x forward earnings, the flip side is that there is also significant potential for these high-fliers to be de-rated if they disappoint. While not named in the article there are a number of other popular stocks which also trade on very lofty multiples and perhaps deserve more scrutiny from investors.
Shareholders in telco services provider TPG Telecom Ltd (ASX: TPM) have enjoyed a rally of 114% in the past year, with the stock now trading on an FY 2015 price-to-earnings (PE) ratio of 22.4.
Education provider Navitas Limited's (ASX: NVT) shares have soared 46% in the past year, to currently trade on a forward PE of 28.4.
While hospital owner and operator Ramsay Health Care Limited (ASX: RHC) has gained 48% in 12 months, and the stock is trading on a multiple of 25.8 times earnings.
Foolish takeaway
While it may feel safe to buy strong performing stocks that are growing rapidly, investors need to remain vigilant and be aware of the hefty multiples these types of stocks can attract. Just as a company which has disappointed you and not met your expectations should perhaps be removed from your portfolio, by the same token it is sometimes best to remove very over-priced stocks from your portfolio as well.
