It’s still a long way from the exclusive ‘comma club’ of companies with shares prices over a $1,000, like Amazon, Alphabet and Berkshire Hathaway, but hearing implant business Cochlear Limited (ASX: COH) changed hands for more than $200 a share this afternoon. That means it’s easily the most expensive share on the local market in nominal terms and some would say on convention valuation terms too given a trailing price-to-earnings per share multiple of 51x, with profit growth in FY 2018 only forecast to reach around low double-digit rates. Using a conventional valuation metric of earnings multiple (51x) divided by estimated…
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It’s still a long way from the exclusive ‘comma club’ of companies with shares prices over a $1,000, like Amazon, Alphabet and Berkshire Hathaway, but hearing implant business Cochlear Limited (ASX: COH) changed hands for more than $200 a share this afternoon.
That means it’s easily the most expensive share on the local market in nominal terms and some would say on convention valuation terms too given a trailing price-to-earnings per share multiple of 51x, with profit growth in FY 2018 only forecast to reach around low double-digit rates.
Using a conventional valuation metric of earnings multiple (51x) divided by estimated growth rates (12%) (the price-to-earnings growth or PEG ratio) leaves Cochlear with a PEG around 4.25, where 1 is considered fair value and over that getting expensive.
In other words according to traditional PEG valuation metrics, Cochlear needs to grow its FY 2018 profit around 50% to be ‘fair value’ at $200.
The actual result is likely to come in around 12% based on the company’s existing forecasts for FY 2018 net profit between $240 million to $250 million.
What’s going on then?
Back in March I outlined a few reasons why Cochlear shares could hit $200 in 2018, but must admit I didn’t expect it to reach the landmark just a few weeks later.
Some of the reasons I outlined included the decent growth in its developed markets business, the growth in its services (recurring revenue) business, the favourable fiscal changes in the U.S., and the decision to build a production facility in China as among the things counting in the company’s favour.
Lower Australian dollar
However, the big driver of the recent share price gains is the falling Australian dollar, with Cochlear earning most of its more than $1 billion in annual revenues overseas.
Therefore drops in the Aussie dollar’s value will boost its bottom line, with its original profit guidance for FY 2018 based on the Australian dollar buying US 80 cents.
Today it’s buying only US 75 cents, which is a fair difference and suggests Cochlear could beat its guidance just on foreign exchange tailwinds alone.
For investors it’s also worth noting that not all growth stocks are created equal, with powerful money mangers tending to cut more slack to those with the widest moats or competitive advantages.
These are what provide pricing power or the ability to raise product prices with little impact on sales over time. Famous investors like Warren Buffett often refer to pricing power or moats as some of the most important qualities to look for in companies as long-term investments.
Recently, Buffett bought heavily into Apple Inc and as with Cochlear you won’t see their products ever going on half price sales or the like.
Cochlear shares are up more than 200% over the past five years, while another healthcare giant with pricing power in CSL Limited (ASX: CSL) has seen its shares also lift more than 200% over the period.
Despite the falling Aussie dollar I wouldn’t recommend buying Cochlear shares on today’s valuation, as I expect patient investors will get a better opportunity between now and the end of 2018.
If you’re looking to buy some of the best, but most expensive stocks on the local market a good strategy is to dollar cost average, or buy fixed amounts of stock several times over fixed time periods of say 6 months in order to spread the market risk.
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You can find Tom on Twitter @tommyr345
The Motley Fool Australia has recommended Cochlear Ltd. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.