As the market continues its ascent, the number of overvalued companies continues to increase. Today I've focused on what I believe to be some of the most overvalued stocks in the market. My criteria are as follows:
- Enterprise value to trailing twelve-month revenue greater than 10x.
- Inability to demonstrate scalability in existing business model.
- Questionable growth prospects
- Insider selling
Zillow's (NASDAQ:Z) stock has been a homerun for investors, increasing 317% over the past two years. While revenue has increased at an 86% CAGR over the past three years, Zillow has been unable to translate revenue growth into operating profits - the company actually lost money at the operating profit line in 2013. Investors in Zillow must believe that the company's strong revenue growth rate will eventually translate into meaningful earnings and free cash flow. To generate revenue growth, Zillow has massively increased its advertising spending which increased 120% last year (vs. just 69% revenue growth). In investor presentations, Zillow likes to point to UK real estate website Rightmove (RMV) which generates 75% operating margins - implying that there are big profits ahead for Zillow. While this certainly seems to have whetted investor appetites, there are significant structural differences between the UK online advertising marketplace vs. the US.
First, and most importantly, Rightmove has ~80-85% market share in the UK vs. 10-15% market share in the US for Zillow. This is important as it 1) is able to spread out its expenses more efficiently but (2) has significantly greater pricing power than Zillow (Rightmove is the only game in town whereas there are multiple competitors to Zillow). Secondly, the UK does not have an MLS or multiple listing service. The MLS ensures that a listed property will be viewable to all agents and reduces the need for advertising. Without the MLS, brokers must advertise heavily and Rightmove dominates this market leading to tremendous levels of profitability. In the US, the MLS reduces the necessity to advertise and there are a plethora of places for agents to advertise leading to low levels of profitability - competitors Trulia (TRLA) and Move (NASDAQ:MOVE) don't earn much either. Selling at 19x trailing revenue (and 13x 2014e revenue), investors in Zillow seem to believe that this will eventually prove to be a high margin business. If Zillow proves to only earn 10% operating margins (still considerably better than history), it is entirely possible that shares could fall 90% - assuming 2014 revenue of $300 million, a 10% operating margin, a 33% tax rate and a 15x P/E multiple. It's unsurprising that insiders have been unloading stock at a rapid clip since Zillow came public.
Veeva Systems (NYSE:VEEV) recently announced a secondary offering which will allow insiders to cash out some of their holdings. As Suhail Capital has so eloquently articulated, Veeva's growth will rapidly slow as it has fully penetrated its core market amongst pharmaceutical clientele. Further, payments to platform provider Salesforce.com limit the potential for margin expansion (and could possibly cause margin contraction as VEEV must meet minimum payment thresholds). Coupled with a valuation of 17x 2014 expected revenue, it is unclear why a rational investor would take a long position in Veeva shares. With insider selling as an imminent catalyst, I expect Veeva shares to move closer to their intrinsic value which I estimate to be less than $10/share (assuming $300 million in 2015 revenue at a 25% operating margin, a 35% tax rate and a 17x P/E multiple gets me to $6/share in fair value). I expect insider selling to continue.
Plug Power (NASDAQ:PLUG) has had a tremendous run over the past year - despite the recent decline in share price, the stock is still up more than 40-fold from its 2013 lows. Speculators are very excited about all things electric power, even companies who have a long history of being unable to convert such exciting products into meaningful revenue (or profits). PLUG has lost money for its entire 12-year history as a public company and while management has made many promises about future profitability, history suggests that they will not deliver. Given the company's history of burning through cash, I generously value PLUG at 50% of the value of the cash on the company's current cash balance (I value it at 50% of cash because I expect PLUG to burn through at least half this cash over the next 12 months). Considering that there are 150 million shares outstanding, this works out to be just $0.20/share (50% * $60 million / 150 million shares). For those looking to benefit from a decline in PLUG's share price, given the high cost of borrowing shares, I recommend instead selling calls (both in and out of the money calls - selling long-dated out of the money calls allows investors to benefit from the extraordinarily high volatility while giving themselves a further buffer against another day trader driven rally). My short position in PLUG has been constructed entirely through selling calls.
Disclosure: I am short Z, PLUG, VEEV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.