If you want a stock market bet that's 74% likely to lose money, try investing in high-flying stock that sells for 100 times revenue or more. I call such investments "near insanity," since in the vast majority of cases these stocks crash back to earth.
How dizzying is 100 times revenue? Well, consider Tesla (NASDAQ:TSLA), a stock often criticized as overpriced. I happen to agree that it is, but Tesla sells for about six times revenue. That's a far cry from 100.
The price-sales ratio for the Standard & Poor's 500 now is 2.43, which is a record high. Over the years, a normal ratio has been around 1.5. The low, in March 2009, was 0.8.
Can a sky-high price-revenue multiple ever be justified? Sure, if the company has developed a blockbuster drug or breakthrough product, and hasn't started marketing it yet. But these are rare birds, much rarer than most people think.
This year, the ranks of stocks selling for 100 times earnings are dominated by early-stage biotech companies.
It's easy for people to imagine superb futures for young biotech stocks. They are using brand-new technology, and their products, if successful, will alleviate pain and suffering - or even save lives.
But consider a few of the exciting technologies of the past: auto stocks in the 1920s, radio stocks in the 1930s, television stocks in the 1950s. A plethora of companies entered these promising fields, and many of them bit the dust.
To make it to market, a drug has to successfully negotiate three levels of clinical trials. Most make it through Phase 1 (a basic safety check), but only 33% pass Phase 2 tests (efficacy), and only about 10% survive Phase 3 (larger-scale randomized double-blind studies).
It's probably beneficial to society that upstart biotech companies can fund important research by issuing stock to the public. But if you're an investor, realize that the odds don't favor you.
One of the most extreme valuations belongs to Adverum Biotechnologies Inc. (NASDAQ:ADVM) of Redwood City, California, which is working on several forms of gene therapy for ocular and rare diseases. It sells for more than 3,000 times revenue.
According to its website, Adverum has one drug in Phase 1 clinical trials and two drugs in preclinical trials (animal testing).
For the moment, annual revenue is about $320,000 while the stock's market value is about $1 billion.
Selling for 1,345 times revenue is Homology Medicines Inc. (NASDAQ:FIXX), based in Bedford, Massachusetts, which seeks cures for nervous-system disorders.
In the past 12 months, Homology had revenue of about $660,000 and a loss of about $100 million. Market value? About $1 billion.
Julian Robertson (Trades, Portfolio), for many years the manager of The Tiger Fund, an extremely successful hedge fund, bought shares of Homology in the fourth quarter of 2018. Possibly influenced by Robertson's tacit endorsement, investors pushed Homology shares up strongly in the first quarter of 2019.
But Robertson bailed out in the first quarter, and since then the stock has descended from about $30 to about $19.
Forty-Seven Inc. (NASDAQ:FTSV) shares have risen 189% in the 12 months through Feb. 14. The Menlo Park, California-based company is working on ways to make people's natural immune systems function better in fighting cancers.
In layman's terms (as explained on the company's web site), many cancer cells give off "don't eat me" signals that stop the body's white cells (macrophages) from destroying them. Forty-Seven is working on drugs that disable these destructive signals. It has two drugs in Phase 2 trials.
The stock sells for 114 times revenue.
Over the past 20 years, I've written 15 columns about stocks selling for 100 times revenue. The average 12-month return on the high flyers I warned about was a loss of 29.8%%.
That compares with an average gain of 9.8% for the Standard & Poor's 500.
Of the 70 stocks I've written about, 52 have declined. Hence, the 74% likelihood of losing money that I mentioned at the outset.
Bear in mind that performance figures for my column are theoretical and don't reflect actual trades. Their results shouldn't be confused with the performance of portfolios I manage for clients. And past performance doesn't predict future results.
The stocks I maligned a year ago managed to post a 5.8% gain. Then again, the S&P 500 was up 21.8%.
Immunomedics Inc. (NASDAQ:IMMU) notched a 29% return, and Denali Therapeutics Inc. (NASDAQ:DNLI) gained 21%. However, Tellurian Inc. (NASDAQ:TELL) dropped 33%.
Disclosure: I have no positions, long or short, for myself of clients, in the stocks discussed in today's column.
John Dorfman is chairman of Dorfman Value Investments LLC in Newton Upper Falls, Massachusetts, and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at firstname.lastname@example.org.
This article first appeared on GuruFocus.