Momentum stocks and small caps have had a rough week or so but given the frothy valuations from which they've begun their descent, this may just be the beginning. While markets remain expensive and investment opportunities are scarce for the long investor, there are several interesting short sale candidates. Here I will profile three stocks which I think will do considerably worse than the broader market indices over the next 2-3 years. My criteria are as follows: Enterprise value to sales greater than 2, P/E greater than 30, and year-to-date share price performance in excess of 35%. At this point in the investment cycle, I'm much more excited about my short positions than my longs - here are three of my favorite ideas:
Five Below (NASDAQ:FIVE) is a mall-based retailer targeting tweens, teens, and their families. Shares have had a fantastic run this year, advancing 56%. Shares now trade at 5x 2013 forecast revenue (and 4x 2014 estimated revenue). Similarly, shares sell at an 81x multiple of 2013 estimated earnings. At this valuation, the company must grow its revenue at a 25% clip for 6-7 years while bringing margins to 13-15% (vs. 8.5% last year) to justify its present valuation. While this is possible, teens are notoriously fickle when it comes to shopping. It has been proven over and over again that what is cool today might be the opposite of cool tomorrow. If this happens, shares have considerable downside- teen retailers like Abercrombie & Fitch (NYSE:ANF) and Aeropostale (NYSE:ARO) trade at less than 50% of revenue. While Five Below has the wind at its back today, were it to stumble and get put into the discount rack, we could see 75% downside (a 75% share price decline would put the stock at 1x 2014 estimated revenue, still a considerable premium to other teen retailers).
Amazon.com (NASDAQ:AMZN) shares have soared 36% year-to-date and now sell at 2.1x 2013 estimated revenue and 200x earnings. Amazon wants investors to believe that it is fundamentally a very profitable business which is investing heavily in its future. While it is true that Amazon is investing heavily into new business opportunities, I doubt that the company will be able to translate its large sales base into profits for investors. I disbelieve that at $75 billion in revenue, Amazon has not achieved sufficient scale to generate profits. Additionally, Amazon's sales growth has slowed significantly (forecast to be just 20-25% or so this year). If we assumed that $50 billion (83% of 2012's revenue) of this base was "mature" business which generated a 6% operating margin [still below Wal-Mart (NYSE:WMT)], this would imply that Amazon is investing $2 billion to generate the other $25 billion or so in revenue (yielding an overall consolidated operating profit of $1 billion). That's an exceptionally high figure for investment - I don't think they are investing that much. Instead, I think Amazon's mature categories are doing just 2-3% operating margins (implying $500 million of investment). In order to take share from traditional retailers, Amazon must be the most convenient, cheapest, retailer. Unfortunately this does not mean that it will necessarily ever be one of the most profitable. Shares could fall 50% or more if investors took a less kindly approach to valuing the business.
Sprout's Farmers Market (NASDAQ:SFM) just reported a strong set of 3rd quarter numbers. I suspect this will allow brokers to upgrade the stock so that they can earn commissions selling the $900 million+ of stock the company indicated would be coming to market (from selling shareholders of course). While brokers may be bullish/about to turn bullish, at 65x earnings and 2.8x revenue, this stock is priced to perfection. Grocery retailing is a tough business and it is about to get much tougher for Sprout's - Amazon.com continues to push forward with its "Fresh" offering in greater Los Angeles which is one of Sprout's largest markets. Similarly we will be seeing a recharged competitor in the form of Wild Oats (which I believe will be the new banner for what was Fresh and Easy). When high priced grocery stocks miss earnings, it isn't pretty - witness the share price declines of Fairway Markets (NASDAQ:FWM) and Whole Foods (NASDAQ:WFM) which fell 21 and 9%, respectively (after a big and small earnings miss). Sprout's is priced to disappoint and could easily fall 67% if competition compressed its frothy 6.7% operating margins and investors applied a more conservative P/E multiple.