I do not spend a lot of time on cyclical stocks and the industrials and materials sectors are not well represented in portfolios I manage. Lack of expertise is one reason, but another tricky part of investing in cyclical companies is that you need to have a decent sense of their business cycles and that is not easy unless you have some specific experience in the industry.
That said, sometimes I dabble when I can get comfortable enough with the company and stock price simultaneously. In early 2016 that combination was staring me in the face after a sell-off in Boeing (BA) prompted me to buy at prices as low as $105 per share. I do not even recall what the particular short-term Wall Street worry was at the time regarding Boeing’s prospects, but if you are going to feel good about the competitive positioning of a large U.S. manufacturer, BA has got to be near the top of the list (nearly impenetrable market share, minimal competition, and fairly predictable product demand).
In 2015 Boeing had posted GAAP EPS of $7.44 per share, up modestly from 2014 and a new company record. At $105 each, the beaten down stock in early 2016 was trading at a trailing P/E of 14x and had posted free cash flow in excess of GAAP earnings for four straight years. It was a classic situation of getting a great business for a very reasonable price.
Boeing shares snapped back quickly, reaching $135 in less than two months. Earnings for 2016 were estimated to rise modestly again, which put the stock at 18x current year earnings, or nearly a market multiple for a cyclical business that was on pace for a fourth consecutive year of record earnings per share. As a result, I rang the register and was pleased with a 20% gain in a very short period of time (the IRR on the trade was over 1,000%).
Today, nearly two years later, Boeing stock closed at $320 per share:
What on earth is going on here?
Company management projects GAAP EPS of $11.30 for 2017 (fourth quarter results are due out later this month), which would be 48% above 2016’s record level. Boeing is trading for 28x trailing earnings, versus the S&P 500 at 22x.
Since when do cyclical stocks earning peak margins trade at premiums to the overall market? Isn’t it usually the other way around? Don’t investors in cyclicals typically pay high multiples on depressed earnings and lower multiples well into the upswing of a business cycle?
Other cyclical companies have seen steep share price climbs lately as well:
This bull market is producing some oddities no doubt. Not too many people would believe that nearly a decade into this economic expansion Boeing would fetch a higher valuation than Google (based on 2018 earnings estimates – CB 1/12/18), but that is exactly the case today. What does it mean? It is hard to say.
Maybe investors truly believe we are in the early innings of the economic cycle and Boeing’s earnings are set to soar more than they already have. Maybe the computer algorithms have taken over and just bid up every momentum-driven stock, regardless of what history would tell you about investing in cyclical companies. Maybe we are entering a melt-up/bubble phase and this market will ultimately hit a P/E ratio of 25 or 30x, with the biggest companies benefiting most due to huge index fund inflows. Maybe putting on a long Google/short Boeing paired trade today will look brilliant five years from now.
Thoughts on Boeing’s valuation? Please share.
Full Disclosure: No position in Boeing at the time of writing, but positions may change at any time