3 Stocks Dragging The Nasdaq Down

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 |  Includes: ATHN, FUEL, NFLX, VOO
by: ADS Insights

Summary

The Nasdaq has diverged from the S&P 500 over the last three months.

Rocket Fuel, Netflix, and Athenahealth are partly responsible for the Nasdaq under-performance.

Even with the declines, the three stocks are still richly valued.

Over the last three months, the Nasdaq and S&P 500 have taken divergent paths. The Nasdaq has decreased almost 3% while the S&P 500 has increased close to 3%.

^IXIC Chart

^IXIC data by YCharts

Rocket Fuel (NASDAQ:FUEL), Netflix (NASDAQ:NFLX), and athenahealth (NASDAQ:ATHN) are three stocks partly responsible for the Nasdaq's underperformance compared to the Vanguard S&P 500 ETF (NYSEARCA:VOO) over the last three months. Rocket Fuel's stock fell 22% after reporting its recent first quarter earnings and has declined over 55% the past three months. Netflix's decline has also been significant over the last three months, falling just short of 14% over that period. Further, athenahealth fell precipitously after hedge fund manager David Einhorn revealed that he was shorting the stock. Even before Einhorn's announcement, however, athenahealth's stock price had been on a steady decline in the last three months, falling just over 40% in that period. In sharp contrast, Vanguard's ETF replicating the S&P 500 increased close to 3% over the same three-month period.

FUEL Chart

FUEL data by YCharts

There has been much talk lately about a bubble brewing in the stock market, especially in technology stocks, which are heavily listed in the Nasdaq. Rocket Fuel's, Netflix's, and athenahealth's valuations display why some investors could conclude that the market and especially technology stocks are approaching overvaluation. Rocket Fuel, Netflix, and athenahealth all trade at considerable premiums to the S&P 500. Interestingly, even after their declines over the past three months, all three stocks still trade at significant premiums.

Still heavily valued after declining

P/E

Forward P/E

P/CF

Rocket Fuel

----

69

-54

Netflix

130

56

145

athenahealth

----

101

40

Vanguard S&P 500 ETF

18

17

11

Click to enlarge

Data Source: Morningstar

Rocket Fuel and athenahealth have no earnings on a trailing twelve-month basis. Looking forward twelve months and considering estimates for positive earnings, both Rocket Fuel and athenahealth are quite expensive. Rocket Fuel's forward P/E is over four times the Vanguard S&P 500 ETF's, and athenahealth's forward P/E is extremely high at 101, putting it almost six times as costly as the ETF on that basis. An investor must ask his- or herself if Rocket Fuel's or athenahealth's earnings are worth that much more than the general market.

Netflix does have earnings on a trailing twelve-month basis, but those earnings are quite expensive with a P/E of 130, a little over seven times the P/E of Vanguard's market replicating ETF. On a forward basis, Netflix's P/E is also lofty at 56 compared to the ETF's 17, a multiple of three times the ETF's forward P/E.

All companies have to generate cash and not just earnings in order to stay viable. Rocket Fuel is in a precarious position with a price-to-cash flow multiple of -54, meaning investors would be paying for a company with negative cash flow over the last twelve months. Investing in companies with no or negative cash flow is always an extremely risky proposition.

Fortunately, for Netflix and athenahealth, both companies are cash flow positive, but paying for that cash based on their respective stock prices puts their valuations in "nosebleed" territory. The Vanguard S&P 500 ETF trades at a P/CF of 11; athenahealth trades at a P/CF about four times that of the ETF and Netflix even trounces that disparity by trading at over thirteen times the ETF's P/CF multiple. Investors must ask themselves if athenahealth's cash flow is four times as valuable as the general market's and even more so for Netflix's.

Stay cautious even after the decline

The premiums that Rocket Fuel, Netflix, and athenahealth command over the Vanguard S&P 500 ETF are quite rich. This is true even after their stocks have declined considerably over the last three months, dragging the Nasdaq down with it. David Einhorn remarked in his latest report to his investors that twice a silly price is not twice as silly, it's still just silly. Taking heed to Einhorn's advice, an investor could also conclude that a half as silly price is not half as silly, it's still just silly. Therefore, the significant declines in the stocks of Rocket Fuel, Netflix, and athenahealth should not be necessarily taken as a cue that they are now cheap and ripe for purchase. Investors should always do their homework before investing in such speculatively valued stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.