Sometimes paying a premium for a stock can be justified. For the stocks we're going to look at today, however, it could take a small miracle and a lot of time for their valuations to make sense. If you own, or are thinking about owning, any of these three names, you may want to see exactly what you're getting yourself into.

Expenses Turn Bitter For Candy
How in the world does a candy company pump up its price-to-earnings ratio to 35.8? Actually, you could ask The Hershey Co. (NYSE:HSY) or Cadbury (NYSE:CBY) the same question. Both have done it and then some. However, the company most concerning to me is Tootsie Roll Industries (NYSE:TR). With a TTM price multiple of 35 and a forward-looking multiple of 36, there is not a lot to look forward to. (For more on evaluating companies using ratios, check out our Financial Ratio Tutorial.)

The shrinking earnings shouldn't come as a surprise considering sugar prices are up 60% in the last two years. In a perfect world the company would just be able to pass those costs along to the consumer via higher prices. That may be tough to do, however, judging by Tootsie Roll's decision to shrink the size of its candy by 7%. It's a nice effort, but it'll take more than that to make these numbers work.

Masimo Raises Guidance, But Not Enough
The good news is that biotech company Masimo (Nasdaq:MASI) raised its guidance. The bad news is that even if it reachs its new target, the stock is still overpriced.

After announcing last quarter's numbers earlier in the month, Masimo went on raise its full year earnings guidance from 52 cents to 64 cents per share. Was it based on a stellar Q2? Nope; its second quarter results were flat with last year at $10.6 million (although per-share income moved from 13 cents to 18 cents).

To Masimo's credit, that was its fourth earnings "beat" in a row, and the company has pulled in 71 cents per share over the last four quarters, so the forecast of 64 cents is certainly more than plausible. The problem? Whether the company will make 71 cents, 64 cents, or analyst's estimates of 78 cents per share in 2009, the multiple is still going to be well over 50. (Find out what these forecasts mean for investors in Earnings Forecasts: A Primer.)

Some medical equipment companies may be able to pull off that lofty valuation for a while, but Masimo isn't one of them and definitely can't do it in perpetuity. It would need to start selling a heck of a lot more noninvasive patient monitors soon. Otherwise, the stock's April-to-August runup from $25 to $40 risks an equal-sized pullback.

Is This The Late '90s? (NYSE:CRM) provides on-demand customer relationship management. The concept is brilliant. The only issue for shareholders is that there's just not much profit in it. earned 8 cents per share last quarter. That was right on analyst estimates. However, when you earn a total of 27 cents per share for the last twelve months, and your stock price is in the mid-$50's, the market's not going to love you.

Oh yeah, factor in the company's own warning of slower-than-expected growth, and now the market's reeeaaalllly not going to love you.

The irony is that the company is on track for one of its best years ever. When your price-to-earnings is 214 though (and projected to be 88 next year, before the dire prediction), what rabbit can you pull out of your hat to ease the pressure? (Read more on this multiple in Understanding The P/E Ratio.)

Incredibly, investors have actually remained pretty patient with It's been overpriced since it went public in 2004. In that four years though, the competition has stepped up to the plate with something free, or better, if not both. Google's (Nasdaq:GOOG) Google Apps and Microsoft's (Nasdaq:MSFT) SharePoint both are nipping at now.

Final Thoughts
Eventually, even if only temporarily, every stock trades at what it's worth. All three of these companies may well lay down a royal flush in the near future. If they had one though, they probably would have played it by now.

It's also worth noting all three of these stocks have managed to move higher (or at least hold their ground, in Tootsie Roll's case) despite their already-stretched valuations. Nevertheless, any of these stocks are vulnerable to just one or two not-so-great quarters; the market's not going to wait forever.

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Tickers in this Article: TR, CBY, HSY, MSFT, GOOG, MASI, CRM

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