Regular readers of my columns know that I am not a momentum investor in any way, shape or form. High P/E stocks that are driven more by their "story" than fundamentals are something I try to avoid like the plague. I will also occasionally short these story stocks with option strategies (I would love to have more straight shorts but the Federal Reserve's policies to push investors into riskier assets make that strategy imprudent at the current time). Two high-flying tech stocks with high P/Es reported earnings after the bell Tuesday. Even though neither report was bad on its face, both stocks are taking big hits in after hours and pre-market trading. This demonstrates the dangers of playing this type of momentum stock. Here is a synopsis of both stocks and why each is still overvalued even after the sell-off that we are likely to see when trading opens today.
Rackspace Hosting (RAX)
Earnings - The company reported earnings of 21 cents a share, three cents above the same quarter a year and matching expectations. Revenues grew 25% Y/Y to $352.9mm, a few million below consensus.
Reaction - The stock is down 9% in after hours.
Rackspace Hosting provides cloud computing services, managing Web-based IT systems for small and medium-sized businesses, and large enterprises worldwide.
4 reasons RAX is still overvalued at $68 a share:
- The company is facing competition from Amazon's (AMZN) web services. Going against a company like Amazon that cares little about profits or margins and only about market share is like trying to out-crazy a lunatic.
- Even after the sell-off after hours, an investor is paying 90x earnings for a stock that grew earnings around 35% and revenues just over 25% in FY2012.
- Out of the last reported 13 quarters, the company has beat earnings estimates 4 times, met expectations 5 times and missed four times. Not exactly a record of consistency for a high P/E stock.
- The stock is selling near the top of its five year valuation range based on P/E, P/CF, P/S and P/B. Insiders have sold over $3.5mm in stock since the first of the year.
Ruckus Wireless (RKUS)
Earnings - The company reported earnings of 7 cents a share, two cents above estimates. Revenues were up over 50% Y/Y and beat consensus by 3%. The company's outlook for next quarter was in line with expectations.
Reaction - The stock is down 5% in after hours.
Ruckus Wireless offers a variety of products to enable Wi-Fi solutions worldwide. The company came public in mid-November. Note: Author wanted but did not get a pre-IPO allocation on the shares.
4 reasons RKUS is due for a breather at $25 a share:
- The stock has doubled since its IPO three months ago. The fact that RKUS is down on an earnings report that beat expectations on the top and bottom line indicates the stock has gotten ahead of fundamentals and needs to consolidate or pull back for a while.
- The stock's forward P/E is just under 90x. Unlike a lot of tech stocks, Ruckus does not have a huge amount of net cash on its balance sheet (approximately 2% of its market capitalization)
- This seems excessive given analysts expect just over 25% revenue growth in FY2013 and FY2014 and the stock has a five year projected PEG of over 5 (5.07)
- The stock has IPO lockups that have not expired and could put some selling pressure on the stock as they do expire.