From a young age children learn from the game of musical chairs that you don't want to be the last one dancing when the music stops – as this is a sure fire way to find yourself out of the game!
Investing based on momentum is similar – the trend is your friend, until it isn't!
Right now some stocks are immensely popular with investors and they appear to be prepared to pay any price to own them simply because everyone else thinks the stock is great too.
This is a dangerous way to invest and pays no heed to the true worth of a company which is the present value of its future cash flows.
Blackmores Limited (ASX: BKL) – there is little doubt that this is a great business, with a very strong management team and seemingly exceptional growth prospects ahead of it.
In fact, when it comes to growth expectations they are spectacular. According to Thomson Consensus Estimates, Blackmores is forecast to increase earnings per share (EPS) from $2.69 in financial year (FY) 2015 to $4.71 in FY 2016, to $6.03 in FY 2017 and then to $8.49 in FY 2018!
This forecast EPS growth is certainly outstanding if ultimately achieved, however, with the share price currently trading around $160, even looking as far out as FY 2018 the stock trades on a price-to-earnings (PE) multiple of nearly 19 times. That's not a ridiculous multiple considering the quality of the business and the above average growth, however, conservative investors would have to ask themselves if there is any margin of safety left in the current share price, or if the share price really deserves to trade any higher in the medium term.
Ansell Limited (ASX: ANN) – In rather stark contrast the earnings growth outlook for Ansell is sanguine (according to Thomson Consensus Estimates) and suggests the company is now a mature, low growth stock.
That certainly doesn't get momentum investors excited, however, the company is a global market leader and operates defensive, solid businesses. Trading on a FY 2018 forecast PE ratio of around 13 times, this stock is arguably around fair value.
