What to Buy and Sell as the Market Climbs: Visa Inc (V), American International Group Inc.(AIG)

Recently the Dow Jones has been flirting with 5 year highs.  While the run has been great it has left some of my favorite companies looking a bit expensive.  It has also made it far more difficult to find buying opportunities.  Here I will examine two companies that I believe are in danger of becoming too expensive and one buying opportunity that I believe represents great value.

Visa Inc (NYSE:V)

It’s always tough to sell great companies, but it sometimes becomes necessary when the market offers a premium compared to historic averages.  While I personally believe Visa is a great company, its valuation lately has left me a bit concerned.  I will admit that Visa is deserving of a slightly higher premium than the competition. However, how much higher is open to debate.  With the stock climbing over 36% in the last year alone it could be time to take profits.

Looking at some key valuation metrics (Figure 1) we can see that compared to the rest of the industry Visa is commanding a hefty premium.

Figure 1:

But let’s take a look at the other side of that trade and examine just why so many people are optimistic on Visa. Visa has the largest user base.  They have the largest dollar amount per transaction.  Finally, they maintain a whopping 5 year average net profit margin of 29.20% vs an industry average 7.40%.

Estimates for Visa are rising and if estimates for the FY of 2013 hold true Visa could earn as much as $8.51, which given their extraordinarily high P/E could put their stock price at $536.  That’s quite a potential return. But remember that one minor mistake could spell disaster.

While Visa is a great company it is currently priced for perfection.  Meaning any sort of bad news could have a severely negative impact on this stock.  A stock priced for perfection is generally my indicator to sell, or at least introduce a trailing stop. Given past price fluctuations it looks as if a 6-8% trailing stop will keep you safe from minor market moves but get you out in time if the big drop does hit.

Netflix, Inc. (NASDAQ:NFLX)

There is sometimes a singular event or unique scenario that can present a profit taking opportunity.  A current example would be the massive rally of Netflix.  Netflix benefited after posting a surprise quarterly result that created a massive short covering rally.  A rally of this nature isn’t based so much on fundamentals but rather the need to cover massive short positions, which pushes up the price and triggers even more buying to cover orders.  Looking at a six month chart of Netflix (Figure 2) we can see that this move has been quick and massive after the Jan. 23 earnings announcement.

Figure 2:

In just a six month time frame this stock has more than tripled from its bottom and almost doubled since the earnings report release date.  This has left Netflix with some less than desirable fundamentals (Figure 3) from a value investing standpoint.

Figure 3:

There are quite a few reasons for becoming a bit bearish on Netflix.  Prior to this move the historic high P/E for Netflix was 460 and this was met with a decline from highs of nearly $300 to lows of $63 in less than one year’s time.  It should also be noted that year over year quarterly earnings per share growth was still at a -77.60%. Finally, the earnings report that triggered all the short covering was not a guarantee of future moves such as this one.  It was a small surprise profit as opposed to the small expected loss. The slim profit margin of Netflix (the five year average being 5%) means those earnings numbers will be difficult to increase significantly.