High Flier
Categories: Trading
Nope. Nothing to do with a Southwest Airlines passenger and California’s legalization of marijuana.
A high flyer is a stock that trades at a high multiple of earnings, or of EBITDA, or of revenues, or whatever metric. It's flying high because investors expect massive growth from the company going forward and have paid up for that belief.
A high flyer might earn a dollar this year and trade for 100 bucks a share with just 5 bucks a share in cash and no debt. 95 times the equity value of the company.
Why would it trade for 95 times earnings ?
Well, in reality...it doesn't. Nobody pays 95 times earnings...at least, not believing earnings would be anything close to flat. That is, nobody would pay 95x earnings for a company growing earnings from $1 to $1.05 to $1.10 to $1.15. And just to frame the math, if they were paying 95 times that dollar, then it’d take 95 years just to get your money back.
And life’s short. Think: Danny DeVito.
So if an investor is paying 95 bucks today, they’re expecting probably something close to 3 bucks in earnings next year. And then 7 bucks in earnings the following year. And then, ok. Things make sense. The company will have, at that point, generated and kept another 10 bucks and change in cash...so the equity value at that point, i.e., in 2 years, would be something like 85 bucks a share.
And then, in earning 7 bucks a share, the company’s equity value is trading at something like 13-ish times 2-year forward earnings, which is actually cheap if they hit their numbers. And super-cheap if they continue to grow anything close to this rate and earn, say, 12 bucks a share the following year. At which point the stock would be trading at a single digit earnings multiple.
The problem with high flyers? Well, they fly high. Where there’s a lot of room to fall should things go awry up there.