The U.S. stock market again has moved to an all-time high — and more than a few investors are worried. Finding stocks to buy is exceedingly tough, with growth names in particular at valuations not seen since the heady days of the dot-com bubble. Stocks to sell, however, are a different story.
Of course, valuation concerns have dogged U.S. equities for most of what is now a ten-year bull market. For the most part, stocks have simply climbed the proverbial “wall of worry“. And those investors who have seen many growth stocks as “too expensive” in many cases have missed out on huge gains.
Even by those standards, however, more than a few stocks have made moves in 2019 that are almost crazy. 31 stocks with a market capitalization over $2 billion already have doubled or better just this year. Many more trade at sales multiples equivalent to earnings multiples for quality companies.
These 10 stocks, in particular, have serious valuation questions. All ten admittedly have real businesses (even if not all ten are profitable), and real reasons why investors have been so optimistic. But at these prices, it doesn’t take much for these overvalued stocks to stumble.
Beyond Meat (BYND)
The gains in Beyond Meat (NASDAQ:BYND) have been beyond incredible. The company originally priced its IPO in a range of $19 to $21. That figure was moved to $25. By the end of its first day of trading, BYND stock had gained 163% to $66.
It wasn’t done. Aided by a big earnings beat, BYND would triple from that first-day close before pulling back. Its upward march has resumed, however: BYND now is up nearly 600% from its IPO price in two and a half months.
There is a real opportunity for the company to disrupt the meat market, as Luke Lango argued last month. But valuation is an enormous question mark. The overvalued stock trades at 25x fiscal 2020 EPS estimates. And the obvious concern is that Beyond Meat doesn’t have the ‘meatless meat’ market to itself.
Indeed, competition is intensifying. Tyson Foods (NYSE:TSN), which sold its stake in Beyond Meat before the IPO, is entering the market. Nestle (OTCMKTS:NSRGY) is on the way as well. Privately held Impossible Foods already has a solid position. So does Kellogg (NYSE:K), whose Morningstar Farms business already sells plant-based meat substitutes.
The optimism toward Beyond Meat’s opportunity makes some sense. The fact that it will have to share the opportunity, however, means that 580% gains and a nearly market-leading price-to-sales multiple both look like too much.
Of late, I’ve largely given up fighting the tape. The company’s new plan to add fulfillment to its offering opens its addressable market — and allows investors to model greater growth for longer, potentially keeping SHOP stock at these levels.
That said, fundamentally, I’m far from convinced. SHOP stock still trades at something like 25x sales — like that of BYND, one of the highest multiples in the market. I still believe, as I wrote last year, that the sensitivity of small businesses to a recession makes SHOP more cyclical than investors realize.
The valuation here simply seems to incorporate perfection. Perhaps Shopify can deliver, particularly as it moves into fulfillment and starts serving larger clients. But even the best business can stumble and there is no room for anything close to a stumble left in Shopify stock.
Zoom Video Communications (ZM)
Along with Beyond Meat, Zoom Video Communications (NASDAQ:ZM) has calmed fears about the tech IPO market that followed the weak debuts of Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT). ZM stock hasn’t been quite as explosive as BYND, but it’s posted big gains, nearly tripling from its $36 IPO price.
The gains aren’t a surprise. Indeed, I wrote not long after the IPO that Zoom stock was the perfect stock for this market. Growth was impressive, potential huge, and valuation — even then — stretched. As I put it at the time, “The point right now is that the numbers can work. And for now, that’s all that really matters.”
With ZM stock nearing $100 again, however, the question is if the numbers can work. Zoom trades at nearly 50x fiscal 2020 revenue. That’s 50x sales — not earnings. The FY21 consensus earnings per estimate is a nickel per share, suggesting a forward P/E multiple nearing 2,000x.
Decades — not years — of growth are priced into the videoconferencing software company. And maybe that growth is coming. But even in a tech space that looks overheated, ZM’s valuation stands alone. And if there is any concern about valuation — let alone a sell-off like that seen at the end of last year, when Zoom was still private — there may not be an overvalued stock more likely to fall than ZM.
It might be a bit unfair to put Square (NYSE:SQ) on this list of stocks likely to crash. It’s already pulled back; even after touching an eight-month high this month, SQ stock still sits 20% below all-time highs reached back at the beginning of October.
Valuation is steep, but in context not that stretched. SQ stock, backing out its cash, trades at less than 70x 2020 consensus EPS estimates. That’s not cheap, to be sure, but relative to other growth stocks in this tech market it seems almost reasonable.
That said, there are real concerns here. The company’s potential move into banking excites some investors, but at this point in the cycle, should be seen as a risk. Competition remains intense. Like Shopify, Square has significant exposure to small businesses (even though it’s been successful of late in grabbing larger customers).
The worry more broadly is that Square’s business model works great now, in a growing economy where its technology is transformative. At some point, the environment will be very different. If investors start focusing on those out-year risks, SQ stock — which fell 50% in a matter of months last year — could be in for another big fall.
Marijuana producer Aphria (NYSE:APHA), too, might seem an odd choice for this list of overvalued stocks. Most notably, APHA stock already has crashed — twice. It fell 75% during last year’s fourth quarter, and after a huge rally has dropped 40% since early February.
But APHA — and other marijuana stocks — still could see much more in the way of downside. Even with lower valuations across the sector, the likes of APHA, Canopy Growth (NYSE:CGC), and Cronos Group (NASDAQ:CRON) still trade at nosebleed revenue valuations. Earnings are negative almost entirely across the board.
And beyond Canada, it’s still not clear from where the next wave of growth comes. U.S. legalization is stalled out until at least 2021 (and likely much longer). Movements toward medical marijuana worldwide are making progress, but recreational legalization is likely to take some time.
Cannabis stocks, including APHA, already are drifting down, as investors lose patience. But valuations remain stretched even at these lower prices, and if growth expectations dim, there’s a lot further for APHA and its peers to fall.
Salesforce.com (NYSE:CRM) could be the granddaddy of this list. Salesforce has been public for 15 years — and it’s looked like a potentially overvalued stock for that entire period. Yet over that stretch, CRM stock has returned a whopping 3,550% — a stunning 26% average annual return. Investors who focused on valuation, and not the business, missed out on those market-leading gains.
In this market, there’s not a ton of reason to suggest that CRM can’t keep flying. But of late, it does look like investors are starting to focus just a bit more on valuation — and competition. Most notably, Microsoft (NASDAQ:MSFT) is trying to take share with its Dynamics 365.
Meanwhile, Salesforce.com has continued pumping out 20%+ annual growth — as it has for years — but CRM stock has stalled somewhat. Indeed, while other software stocks have soared, CRM has traded sideways since the beginning of February.
The problem is that CRM stock, even after half a year of flat returns, still isn’t cheap — or close. The stock trades at 46x next year’s earnings, which isn’t terrible considering its growth. But as I noted earlier this year, some two-thirds of the company’s guidance for adjusted net income comes from the exclusion of stock-based compensation. That’s a real cost, that dilutes CRM stockholders. Back that out, and a 20-year-old company is trading at something like 140x forward earnings.
In this market, investors have been happy to ignore stock-based comp. If and when that changes, CRM stock is going to fall.
Etsy (NASDAQ:ETSY) has a great business. It’s dominant in the crafting space, having dispatched potential competition from Amazon.com (NASDAQ:AMZN). The company was able to raise seller fees last year, which gave a big boost to revenue, margins, and the ETSY stock price.
But at the end of the day, Etsy remains a mostly niche business. Growth in its industry likely is limited. Like Square and Shopify, Etsy may be benefiting from the ‘newness’ of the platform. Businesses will fade, whether due to a recession or simply an increasing realization that the returns don’t match the investment.
Even down 11% from early March highs, none of those risks are priced into ETSY stock. It still trades at well over 10x revenue, even backing out its cash, and over 50x next year’s EPS on the same basis. And as I wrote in April, even the company’s five-year targets suggest upside is limited.
To some extent, given the soft performance of ETSY in recent months, investors may be coming to the same conclusion. But if ETSY’s valuation gets reset that of a company with a relatively limited market and a potential ceiling on its growth, the soft drift of the last few months could become an accelerating downturn.
Lululemon Athletica (LULU)
What Lululemon Athletica (NASDAQ:LULU) has accomplished is rather incredible. At a time when retailers — and particularly apparel retailers — are getting hammered, Lululemon continues to drive impressive growth. Thanks in part to a Q1 earnings beat, LULU stock has hit all-time highs and might seem to have further to go.
But at 34x forward earnings, even backing out net cash, it’s not hard to wonder if the rally has run its course. Lululemon isn’t going to be immune from the pressures on retail forever. ‘Athleisure’ is a hot trend at the moment; like all trends, that won’t last forever. One only need to look at Gap (NYSE:GPS), whose Athleta nameplate is a minor Lululemon competitor, to see what happens when ‘cool’ turns ‘uncool’.
To be sure, that type of shift may not happen at Lululemon to the same extent: the demand from athletes for its clothes likely will persist. But LULU remains priced for years of growth – and it’s not hard to see that growth stalling out when the next hot trend comes along.
The turnaround at Snap (NYSE:SNAP) clearly has made some progress. User growth is returning. Snap’s ability to monetize those users via advertising sales — particularly outside the U.S. — is improving dramatically. Several Wall Street analysts have jumped on board as well.
As a result, SNAP stock has been one of the year’s biggest gainers, rising 171%. But SNAP also has begun pulling back, dropping 10%+ in the last few sessions – and more downside could be ahead.
Most notably, SNAP stock’s valuation has returned to the stratosphere. It’s still burning cash and posting negative Adjusted EBITDA. SNAP trades at about 8x next year’s revenue – a big multiple relative to profitable and entrenched social media plays Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR).
Again, Snap Inc deserves some credit — and SNAP stock deserved some sort of rally. But 170% looks like far too much as investors are starting to realize.
Roku (NASDAQ:ROKU) has taken a modest hit after Netflix earnings but still sits just off all-time highs. It’s outperformed even SNAP, gaining 257% so far this year — the best performance of over 700 stocks with a current market capitalization over $10 billion.
Here, too, there are some reasons for optimism. Roku obviously is a play on streaming. And with new platforms coming from Disney (NYSE:DIS), AT&T (NYSE:T), and Comcast (NASDAQ:CMCSA), it’s not hard to see why investors are excited.
But this isn’t exactly a risk-free story. Roku gets little in the way of revenue from Netflix or Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) unit YouTube. Its player sales — about one-third of guided 2019 revenue — are unprofitable. The current valuation is something like 17x platform revenue at a time when most media and content companies are trading at low- to mid-single-digit multiples. Even NFLX trades at less than half that multiple.
This seems like another case where investors are paying any multiple for growth — yet perhaps aren’t understanding the full story. Roku has growth ahead — but like so many overvalued stocks on this list, potentially not nearly as much growth as investors are pricing in.
As of this writing, Vince Martin is long shares of Gap Inc. He has no positions in any other securities mentioned.
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