Investing in stocks with high valuations isn't necessarily a bad decision, but it's something to be done deliberately and with caution. Today, the market's average price-to-earnings (P/E) multiple is around 30.6. So stocks with P/E ratios that are higher than that might be a bit overvalued -- or perhaps opportunities to pay a premium for a high-quality investment.
This year, I'm going to be particularly watching three companies with valuations on the higher side, and you might want to as well. Even if you don't buy them, they're probably worth tracking. Here's why.
1. Eli Lilly
As the creator of the blockbuster weight-loss drug Zepbound, and the blockbuster type 2 diabetes drug Mounjaro, Eli Lilly(NYSE: LLY) is exposed to a tremendous amount of opportunity. But with a P/E of 79, few would call its shares a bargain.
The question is whether it can continue to sustain its relatively rapid growth long enough that those who buy it today could get a good return. For reference, its trailing-12-month operating income is up by an impressive 71% in the last three years, reaching $15.1 billion. Nonetheless, new evidence suggests that the bull thesis is starting to become a bit tempered, rather than more exuberant.
On Jan. 14, Lilly published updated guidance for the 2024 calendar year, indicating that revenue in the fourth quarter would fall roughly $400 million beneath the floor of $13.5 billion that it had provided in prior guidance to investors. Responsible for the underperformance: weaker-than-anticipated sales growth of the very medicines that management hopes will drive the pharma's growth in 2025 -- Zepbound and Mounjaro.
This issue may just be a blip, and that's certainly what management is trying to signal. If it isn't, and the growth of those two drugs continues to be slower than expected for another couple of quarters, it'll be a sign that the stock is too expensive to be worth buying. In contrast, if growth accelerates back to where it was expected to be, it'll be an affirmation of the investment thesis for the stock, even at its present valuation.
2. Costco Wholesale
As it's one of my favorite stocks, I'm always interested to hear about what's going on with Costco Wholesale(NASDAQ: COST) despite its current P/E of 55.7, and I plan to keep accumulating it for as long as it continues to perform well. Over the last 10 years, its trailing 12-month net income climbed by 234%, reaching $7.6 billion, and I anticipate that pace continuing.
But there are two reasons that I watch this investment a bit more closely than I usually would. The first is that Costco has a new CEO, Ron Vachris, who has worked in various roles in the business for more than 40 years. To evaluate this CEO's performance and its probable impact on the company's trajectory, it's necessary to pay attention to what he does and the rationale he provides for it.
The second reason I'll be watching closely is that Costco's employees may be going on strike in February. Traditionally, one of the company's advantages was that its employees were highly loyal and also efficient, due to the better-than-average benefits and the opportunities for promotion it offered. It seems as though that advantage may be in jeopardy now, with the potential for detrimental and long-lasting consequences if the situation isn't resolved gracefully and quickly.
Furthermore, it's obvious that the potential for a strike is a serious test for the new CEO, so there's a lot riding on the next couple of months. Depending on how it goes, my core investment thesis for the stock may be damaged -- or reaffirmed.
3. Nvidia
Nvidia(NASDAQ: NVDA) isn't a company that I hold shares of or plan to buy anytime soon, though I'm not under the impression that its P/E of 54.6 is wildly overvalued. Instead, I'm keeping track of Nvidia because I view it as a critical bellwether for the market's general sentiment, as well as its health.
It's one of the largest businesses on the stock market, and it's also one of the players getting the most attention in the race to produce hardware for artificial intelligence (AI). Its trailing 12-month operating income is just over $71 billion, a gargantuan upward climb of around 2,400% compared to just five years ago. All signs point to the good times continuing, as AI adoption isn't about to slow down in the near term.
Still, the market has unreasonably high expectations, which are partially reflected in Nvidia's valuation today. If the company's growth starts to slow, its shares will start to tumble purely due to the market correcting those expectations. When that happens, due to Nvidia's massive size in relation to the rest of the market, it's very likely that (at least for a while) it will drag down the entire market with it.
There's no guarantee that this will happen. But I'd rather stay informed about the company just in case there are any warning signs to be aware of at some point.
Should you invest $1,000 in Eli Lilly right now?
Before you buy stock in Eli Lilly, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and Eli Lilly wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.
Consider when Nvidia made this list on April 15, 2005... if you invested $1,000 at the time of our recommendation, you’d have $901,323!*
Now, it’s worth notingStock Advisor’s total average return is934% — a market-crushing outperformance compared to177%for the S&P 500. Don’t miss out on the latest top 10 list.
Alex Carchidi has positions in Costco Wholesale. The Motley Fool has positions in and recommends Costco Wholesale and Nvidia. The Motley Fool has a disclosure policy.
