Market moves

RIM's skid shows why growth stocks are sometimes Lulu And Dividends are Important

November 13, 2007

One of the dangers of investing in high-growth companies is that, when the stock market stumbles, they're often the first to get trampled. That's because expectations are so high with these stocks that any whiff of trouble sends investors racing to the exits.

Witness yesterday's 5.2-per-cent plunge in Research In Motion. Granted, RIM has been a fabulous stock over the past few years as the BlackBerry maker smashed sales targets quarter after quarter. But that's of little comfort to anyone who climbed aboard prior to yesterday's rout, seduced by brokerage houses that ratcheted their price targets to the moon.

In fact, RIM's plunge had little to do with RIM. It was sparked by the CEO of Cisco Systems, who cited "dramatic decreases" in orders from financial institutions. The reason RIM investors jumped ship is that, if banks aren't ordering routers and switches, maybe they'll stop buying BlackBerrys, too.

Whether that's true or not, the comments - coupled with a downbeat economic outlook from Federal Reserve chairman Ben Bernanke - touched off an avalanche of selling in technology stocks, which before yesterday had been seen as one of the few safe places to ride out the turbulence in financial markets.

RIM - which trades at about 58 times estimated earnings for the current fiscal year - isn't the only high P/E stock getting smacked around. Even outside tech, reality is beginning to set in for some of the market's high fliers.

Consider Lululemon Athletica, the retailer of trendy yoga wear. The company went public in July at $18 (U.S.) a share and promptly saw its stock shoot skyward, briefly topping $60 last month. But it's been all downhill since then; yesterday, it closed at $41.66 on the Nasdaq stock market.

Even after the recent skid, Lululemon probably has further to fall. Analysts expect the company to make 35 cents a share in the year ending in January, so the P/E multiple is a ridiculous 119. Looked at another way, the earnings yield - the flipside of the P/E - is just 0.8 per cent. Would you invest in anything promising such a puny return? A lot of investors have done just that.

True, Lululemon is a growth company, so its earnings will rise. But even if we take next year's estimate of 58 cents a share, the stock is still trading at a lofty 72 times earnings. In other words, for every buck Lululemon is expected to earn next year, investors are willing to pay $72. We'll pass, thanks.

For our money, a better retail stock is American Eagle Outfitters. The U.S. company, which caters to teens and twentysomethings, has been hurt by unseasonably warm weather and fears of a slowdown in consumer spending. As a result, the stock now trades at less than 12 times current-year earnings.

That's a bargain, considering American Eagle's revenue and profit are expected to grow at double-digit rates this year and next. What's more, the company is rolling out new chains - including Aerie, which sells intimate apparel and casual "dormwear" - that will drive growth in future years. And unlike RIM or Lululemon, American Eagle pays a dividend, and it's been growing quickly.

Another dividend grower whose stock has been hammered is Bank of Montreal. Pummelled again by the turmoil in credit markets, BMO fell as much as 2.5 per cent yesterday, before paring its loss and closing at $59.46 (Canadian), down 0.6 per cent. It's intraday low was $58.25, lower than any point in the credit crunch of August.

If you believe BMO is going broke, then stay away. If, on the other hand, you believe the bank will recover from its current troubles, then its multiple of about 11 times this year's earnings has to look tempting. If that doesn't grab you, maybe the dividend yield of 4.7 per cent will.

It's your choice: You can own stocks like RIM and Lululemon that have huge built-in expectations. Or you can own BMO and American Eagle, which have almost no expectations at all.

JOHN HEINZL is an investing reporter and columnist with The Globe and Mail's Report on Business.