As I've gone though and written several articles about macro topics and the market in general, I found myself profiling a couple of companies and making semi-compelling cases to myself for the following three companies that I'd consider big risk/big reward shorts. The risk in these three companies is significant, as they've all seemed to move without rhyme or reason, skyrocketing upwards over the past year; but, as everybody knows, what goes up must come down.
Just don't tell Bernanke that.
1. LinkedIn (LNKD)
LinkedIn has gone absolutely bananas over the past year, up 34% in the last 3 months alone and yielding 121.9% over the last twelve months.
Even though these social media stocks are just as volatile going up as they are going down, LinkedIn's fundamentals are off the charts. With a market cap of 25.89 billion and a P/E of 885, this company's valuation is based strictly on intense forward looking speculation. Folks, this is a resume and networking website we're talking about here - $25 billion market cap!?
The rate at which this company is going to have to grow (in ideal market conditions) is going to have to breakneck to sustain these numbers.
I recently featured LinkedIn in my article about what I feel will be the coming social media bubble bursting:
No sector has just blindly taken off with the furiousness that the social media sector has over the past couple of years. It has some stark similarities to the dot com boom in 2000; similarities that shouldn't be ignored. Names like LinkedIn (LNKD), Yelp (YELP) and Facebook (FB) have been on a tear as of late, easily outperforming the market as a whole. Even smaller and less well known companies like Angie's List (ANGI) and Groupon (GRPN) have been outperforming the market significantly. We have gone crazy for our social media stocks, as this chart indicates:
12 Month Performance
Lest we forget that even though all has been good and well for the past 3 years, the market isn't always the "vacuum for growth" that it is during a bull run. Companies like LinkedIn that are fundamentally out of whack are going to be the first companies to suffer if the major market indexes decide to correct anytime in the near future.
Also, as I've stated in the past, LinkedIn is going to be facing serious competition at some point soon:
LinkedIn doesn't really carry with it anything proprietary, and in the world of social media and websites, cloning ideas, improving on them, then launching them as your own has become commonplace. We went from Friendster to Myspace, before we finally got to Facebook . We went from Napster to Kazaa to Limewire, before we finally got the iTunes store.
The overlay with website ideas is actually quite apparent if you take the time to look. Sales has Amazon (AMZN), Overstock (OSTK), and eBay (EBAY). Travel has Travelocity, TripAdvisor (TRIP), Expedia, Kayak and Priceline (PCLN). Review sites are now everything from Google (GOOG) to Yelp to Angie's List . Aside from the already founded "job networking" sites like Yahoo's Monster.com (YHOO), LinkedIn is absolutely going to be faced with new competition over the coming years, if not months.
It's worth noting that stocks like this one, Netflix (NFLX) and Yelp have all moved up without rhyme or reason right before my eyes before. So, remember, with volatile stocks comes action without reason sometimes, and that can be a risk.
2. Herbalife (HLF)
If a pyramid scheme makes all parties involved tons of cash for the time being before crippling - does anyone notice or care? It doesn't look like it. Herbalife is another stock that has simply killed over the past year. It has yielded close to 100% from the beginning of 2013.
It's important to note that in the face of the market being chaos and companies like LinkedIn carrying insane valuations, anything's possible. I mean, does it seem obvious to me that Herbalife's a short? Yes. Does that mean the rest of the market is going to feel the same way? No. I called HLF a short in the beginning of 2013; obviously, that wasn't the right call. Is this a case where I'd double down and continue to short? Definitely.
Aside from the fact that the company's business model is in question and the fact that it's nearly doubled in market cap in the last 6 months, there's a couple other reasons that Herbalife is sketchy.
The company is still relying too much on international sales. They're still conducting 80% of their business outside of the US right now, and it's strictly because in order for a pyramid scheme style business to work, you're going to need more and more people. One of the reasons HLF finds themselves flourishing in China is due to the dense population there.
From Herbalife's own filing, they even acknowledge that they rely strictly on distributors:
Our failure to establish and maintain distributor relationships for any reason could negatively impact sales of our products and harm our financial condition and operating results.
We distribute our products exclusively through approximately 2.7 million independent distributors, and we depend upon them directly for substantially all of our sales. To increase our revenue, we must increase the number of, or the productivity of, our distributors. Accordingly, our success depends in significant part upon our ability to recruit, retain and motivate a large base of distributors. The loss of a significant number of distributors for any reason could negatively impact sales of our products and could impair our ability to attract new distributors. In our efforts to attract and retain distributors, we compete with other network marketing organizations, including those in the weight management, dietary and nutritional supplement and personal care and cosmetic product industries. Our operating results could be harmed if our existing and new business opportunities and products do not generate sufficient interest to retain existing distributors and attract new distributors.
Did I mention that the company is based out of the Cayman Islands? Too many red flags here, and I contend that overvalued Herbalife's still a short. Remember, with volatility that can move a stock 100% in just months, there's always significant inherent risk, as well.
3. Tesla (TSLA)
It's tough to get down on Tesla, because at the end of the day I really do dig what they're doing and ultimately wish the company success. It's that right now, however, I find the stock to be overvalued and a good short after running a ton and as the ZEV gravy train tapers off.
Tesla has provided derivative style returns over the last year, yielding 411% for investors that bought just twelve months ago; absolutely unheard of returns. Hoping that the Tesla gravy train continues, investors have been piling into the stock furiously in the past 6 months, as you can see from the above chart.
Aside from fundamentally and technically being through the roof right now (the RSI has been riding the overbought line for 4 months now), there's a couple of things that I noticed from the recent Q2 earnings that other investors seemed to love. As the companies ZEV credits start to wane off, revenues pull back as well. The average sale price of a vehicle also declined to $68k from $99k in Q1.
SA Contributor Odysseus points out that this regression isn't supposed to happen this quick:
This was not supposed to happen this quick, but re-affirms the fact that the typical consumer is going to pay much less than the initial rush of the ultra wealthy that wanted the highest price model. The Gross Margins (without ZEV credits) increased by almost 9%, but are still 11% away from their goal of 25%, which might not be achievable since they are outputting more than ever.
Aside from relying on ZEV credits to post the "impressive" numbers that the market seems to like, Tesla is yet another company that's going to be susceptible to any major market corrections. As I feel we are due for a major pullback from a macro perspective, this is one stock I would not want to be long in, should the market start to panic and pull back at some time.
Like the title says, this is a big risk/big reward scenario. I'd argue all three of these stocks are prime for the shorting. Like all stocks that I take a short position on, it's nice to know that even if the company is overvalued and the stock is a good fundamental short, that you're likely to cash if the market as a whole starts to stall the way it has been over the past few weeks. As soon as that gate starts to swing the other way, and a little volatility and fear hit the markets, shorts across the board win. Always note your risk, and best of luck to all investors.