In my last article, I wrote about 20 statistically cheap names for possible long term investment. In this article, I am evaluating 10 stocks which appear to make poor longer investments according to our analysis of current growth rates, DCF valuations, and industry dynamics. All stocks listed will be valued using the past trailing twelve month earnings growth rate or the analysts' projected growth rate over the next five years, and a 1% terminal growth rate after that. I am using an 11% discount rate, which may be a bit high, to discount future cash flows back to their net present value.
Although many momentum investors own the stocks I'm about to discuss, once the buying frenzy ends, these names could actually trend much lower in the coming years and quarters despite their market leading positions and best of breed business models. Most investors seem to be riding a wave of rising prices without paying attention to earnings. As Buffett says, price is what you pay, value is what you get.
OPEN – Opentable.com is trading at 158X earnings, 73X forward earnings, and boasts 44% sales growth. If investors assume that OPEN will grow EPS of $.51 at a 50% growth rate over five years with growth of 1% thereafter, OPEN is currently worth only $30 per share. Open has a PEG ratio of around 2, meaning my 50% earnings growth rate is likely more conservative than most Wall Street analysis. Growth in earnings at a higher than 50% rate would better justify current prices.
LULU – Lululemon.com trades at 54X trailing earnings, 39X forward earnings, a price to sales of 9X, and a price to book value of 15.83. LULU makes yoga apparel, and while I like the clothing and lifestyle, the company must grow earnings at approximately 47% per year using our DCF model to justify its current valuation.
HDY – Hyper Dynamics trades for 37X book value per share, and has no earnings currently. Valued at $726MM, HDY shares are up because of their land lease deal with Guinea which covers over 10,000 square miles. HDY will likely strike oil and become a larger company in the future, but at today’s prices these potential gains may already be priced into the stock.
CRM – Salesforce.com trades for 262 times trailing twelve month earnings. If we assume CRM will earn $1 next year (up from $.55 this year), and can grow earnings at 50% per year for the next five years, and 1% yearly thereafter, the stock from a DCF perspective is worth $59.00, according to our model. This makes it the most overvalued stock in this list.
CMG – Chipotle Mexican Grill trades for 45X TTM earnings and 9.55X book value. If Chipotle can grow EPS of $5.17 at 30% per year for the next five years and 1% thereafter, CMG is worth $157 per share according to our DCF model.
AMZN – Amazon.com trades for 77.5X earnings on EPS of $2.75 per share. IF AMZN can grow earnings at 40% per year for the next five years, and grows at 1% thereafter, AMZN is worth $117 per share. With the company trading at “just” 2.75X sales and a 2.71 PEG ratio, AMZN will need to aggressively build out their higher margin cloud computing segment just to maintain its current stock price.
NFLX – Netflix trades at a whopping 73.3 times earnings of $2.64 per share. One aspect of NFLX that makes it a bit cheaper than it appears at first are their large cash flows from operating activities, which make this a tough short. NFLX will have to grow earnings by 50% per year in each of the next five years and grow earnings at 1% per year thereafter to maintain its current stock price. Could it happen? I think it's a risky bet, but stranger things have happened.
APKT – Acme Packet, another cloud firm, is a bit cheaper than CRM on earnings with a 59X forward P/E ratio, but more expensive on sales, with a 19X price to sales ratio. If APKT earns $1 next year and continues to grow at 50% over the next five years with a 1% terminal growth rate, APKT is worth $59 per share – which is just a buck below the current stock price, making it a better bargain than CRM on earnings. The numbers don’t always tell the whole story, and CRM is the market leader in the cloud.
SPG – Simon Property Group is a REIT that trades at 59X earnings (although REITs pay out cash flows as dividends) and sports a 3.2% yield. At 6X book value, we have no real way to value their properties as they were booked at cost a long time ago, but we can assume that free cash flow of around 1.3 billion should be worth no more than a 20X multiple to these cash flows, or a 10% discount or so from current prices. SPG is not glaringly overvalued, but if the stock rises 30% or more without a similar gain in free cash flow, the stock will be quite expensive.
IWM – The iShares Russell 2000 trades at over 27X earnings and over 3.47X book value. These are multiples generally found at market tops, or at least in periods of irrational exuberance. Investors putting capital to work at these levels in the IWM should read my article “20 statistically cheap stocks worth researching further” for investments that will grow and not destroy capital investment over time.
So there you have it, 10 highly overvalued stocks that might be used as hedges against long positions when a bear market erupts. Until a bear emerges, selling near month at the money put options against a short position, or buying put spreads on these issues, is likely the most conservative path to gains ahead, as overheated markets can remain overheated longer than most investors imagine.
Here is a link to my favorite DCF site.
Disclosure: I am short OPEN, IWM, LULU, CMG, CRM, HDY, AMZN, NFLX. I am long puts on APKT and short 1.5X that amount of lower strike puts and many times hedge both long and short positions using options.