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Stock Screen: High Price-to-Earnings Ratios - September 28, 2012
Although mathematically simple, taking a company’s price and dividing it by its earnings can tell an investor a great deal. The P/E ratio, as it is called, shows how much investors are willing to pay for a dollar of earnings. So, if a company has a stock price of $20 and earnings of $1.00, its P/E would be 20.0. Each dollar of earnings is worth $20 to the market. If that same company, trading at $20 per share, earned $0.50, however, the P/E would be 40—investors would be paying $40.00 for each dollar of earnings.
The price to earnings ratio is a valuation metric, helping to decipher if a stock is expensive or not. Although some use absolute metrics (a P/E over 20 is expensive, for example), P/E is most useful on a relative basis, comparing one company to its historical norms, to another company, or to an industry or market average. It is a way to measure that voting machine mentality of Wall Street about which Benjamin Graham wrote. The thought is that growth and momentum investors are willing to pay more for a dollar of today’s earnings to invest in a quickly growing company. A value investor, meanwhile, would prefer to wait until a company is “on sale” and trading at a low P/E multiple.
Every week Value Line publishes screens of the highest P/E ratios in the Index section of The Value Line Investment Survey. For this screen, we have chosen to highlight Calavo Growers (CVGW).
Calavo Growers is a global leader in the distribution and marketing of raw avocados, as well as other fresh produce items ranging from tomatoes to tropical fruits and vegetables. In addition, it has a value-added fresh food business, Calavo Foods, which manufactures and distributes guacamole, hummus, salsa, and tortilla chips under the Calavo brand. Finally, its wholly owned subsidiary, Renaissance Food Group, markets and distributes a portfolio of healthy, high-quality lifestyle products under the brand names Garden Highway and Chef Essentials.
Calavo sells avocados to supermarket chains, wholesalers, food services, and other distributors, under Calavo and private brand labels. During fiscal year 2011, the company’s top five and top 25 largest customers represented approximately 22% and 44% of its total consolidated sales, respectively.
According to the California Avocado Commission, the company handled approximately 28% of California’s 2011 hass avocado crop (the predominant avocado variety). California avocados are available year-round, with peak production periods occurring between January through October. It also imports from Mexico, Chile, Peru, New Zealand, and the Dominican Republic, giving it a level of supply stability that few competitors enjoy. During 2011, Calavo packed and distributed 23% of the avocados exported from Mexico into the United States, and approximately 5% of the avocados exported from Mexico to countries other than the United States.
The company has been having a solid year thus far, and Value Line analyst Eric Manning expects earnings to be strong in the second half of 2012. Indeed, fresh avocado volumes in California are snapping back nicely from last year’s cyclically smaller harvest. On the downside, there is currently an abundance of supply in the marketplace, which is reducing selling prices. Still Calavo’s profits stand to benefit from the expected large volumes. Favorable conditions, alongside strict cost-management efforts and lower fruit costs in Mexico, should lift Calavo’s top line, margins, and profits.
In general, many Americans are becoming more health conscious, which ought to benefit CVGW’s bottom line for years to come. Previously, the relatively-high fat content of avocados discouraged many people from including them in their regular diet, even though they are rich in vitamins. However, this stigma has been largely erased in recent years as consumers are becoming more informed about the type of fat in Avocados, which is called monounsaturated fat. This is considered a “healthy fat” because it has been proven to reduce LDL cholesterol levels and decrease risk of cardiovascular disease.
In addition to being healthy, the fruit has been showing up on more and more menus for its enjoyable taste. For example, dishes that include the fruit are now available at Subway sandwich shops, Panera Bread (PNRA), and Yum Brand’s (YUM) Taco Bell just to name a few, and they have long been a favorite of Chipotle Mexican Grill (CMG) patrons. We see the rising use of avocados as a good sign that the company will be able to maintain earnings growth. This is likely contributing to the stock’s high valuation compared to other names in the food processing industry (the price-to-earnings ratio is currently at 23).
Even though CVGW is a small cap stock —a group that is relatively volatile— it tends to move in line with the broader market averages (Beta =.90). It also has a solid dividend yield, which currently clocks in at 2.3%. Although this stock is not particularly cheap, we think investors will likely be rewarded over the long term.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.