Warren Buffett famously said to be "greedy when others are being fearful and to be fearful when others are greedy." While many tech stocks look cheap here on cash flows including Microsoft (MSFT), Hewlett Packard (HPQ), Intel (INTC), Tech Data (TECD), Ingram Micro (IM), Cisco (CSCO), and others, the average technology name right now looks a bit pricey. Whether it's the rush to social media, the excitement surrounding "the cloud," or the breakthroughs in 4G technology, companies in the web 2.0 space are looking out of touch with private market multiples.
For the past few months, I have argued that investors buying shares in social media and web stocks would likely be better off buying their own web site on a private exchange, like Flippa.com, where sites that are social media oriented are being sold for a mere 1X earnings in some cases. Of course, large sites with an established user base have economies of scale and wide moats, but on a pure valuation basis much of the premium in valuation is looking a little out of place.
Twitter, for example, has seen its valuation more than triple in the past year. Maybe this is rational, but more than likely it is a form of mania -- I notice the large rush to IPO right now and remember the late 1990's when you either went public and made you tens of millions from selling stock to naive investors, or your site ended up in most cases being worth next to nothing after the crash. While I am not saying that online stocks at 400X earnings are all going to collapse at some point, I am aware that for every Facebook there is a Myspace in the making.
Most investors think that stocks can only go in one direction, and that direction is up. They think that just because a company is a good business, their stocks make good investments regardless of valuation. It just takes one glance at a ten year chart of CSCO, INTC, MSFT, Micron Technology (MU), the Nasdaq index (QQQ), etc... to realize that it's not just the quality of a business that leads to investment success but also the price you pay for that businesses stream of future cash flows.
Here are 4 stocks which I view as too risky to own at current prices and why. Keep in mind, I could of course be wrong and these stocks could move much higher.
OpenTable Inc. (OPEN) -- shares of Opentable have more than tripled over the past year, but with monthly unique visitors of only 2MM or so, we wonder if investors would be better off buying their own website and spending that money on Google Adwords given the lofty price to earnings multiple of 128X trailing earnings.
OPEN is an interesting concept and a well run company, but the fact that the CEO left to join a venture capital firm shows that the growth of the business may be less easy to come by moving forward. That said, this stock is a tough one to trade, so investors who are bearish should either buy a put spread, or sell a bear call spread to limit their risk. We like selling the August $87.50 calls for $6.70 here and buying the November 110 calls for $2.60 or so per contract.
Theta decay, or time decay is working for us in this trad, so we are essentially making money in our sleep, waiting for the option to expire worthless in a little over one month, Additionally, if the stock trades above $95 or so in the next month, we will not really lose too much money on the trade as the $110 calls should expand more than the front month call because of time value. Plus, we still have two more months of premium to sell, which could give us a full $18 of premium to sell between now an October expiration, basically letting us break even if the stock jumps over $100 over that time frame.
Travelzoo Inc. (TZOO) -- Investors cannot trade options on Travelzoo, which makes shorting this high flyer quite difficult. We suggest setting tight stop loss orders on this name, because the stock is incredibly volatile and heavily shorted. We think eventually this name could tumble back to $30 a share, but in the short run anything can happen.
With Europe CDS blowing out, risk-off may soon hit the market, but the bottom line is that investors need to be nimble shorting momentum names that are overvalued like TZOO. One thing to bank on with these stocks is volatility. By shorting the stock and setting a tight stop loss, you put volatility on your side, but you have to expect several shorter term losses before you earn longer term gains which more than make up for the small losses you take from getting stopped out.
Green Mountain Coffee Roasters Inc. (GMCR) -- Green Mountain has a stock chart that just won't quit. Investors usually don't want to buy stocks that are rising literally straight up, so we think a collapse in price is going to hit GMCR in the very near future. We like bear call spreads here, and would consider selling the October $100 calls on GMCR and buying half as many October $120 calls for a hedge.
Green Mountain is trading for well over 110X earnings and I don't buy the forward guidance. Analysts think this is trading for 40X forward eps, but I tend to be skeptical of this business because of a net tangible deficit and rising receivables and short term liabilities. GMCR is a great business, but I think their aggressive growth strategy may hit a snag in the medium term.
The chart is hyperbolic, and even though the name could run even further, the odds are against the bulls in my view as the name has run over 300% in the past six months. Momentum here is a serious risk for shorts, so I would not leave an open-ended short position out on this name unless we begin a confirmed downtrend in equities. That may happen, because only around 64% of American men over 20 actually have a job.
Salesforce.com Inc. (CRM) -- The last time I wrote about Salesforce, I said that the stock was extended and that investors should watch $153 or so for a stop loss on a short position. Since then, the stock has been all over the place, falling to the mid $130s and then bouncing back with the last two weeks of vertical rallying to close over $156 a share.
I would use the same strategy here for shorting this as last time -- sell the August $160 calls and buy half as many of the October $180 calls for a hedge. If the overall markets remain bullish, simply buy more October calls. In the end, time decay will be working on your side and CRM is not likely to hit $200 unless a true 2000 like bubble begins for stocks, which is tough to envision given the weakness in housing and the high rate of unemployment out there.
Disclosure: I am short GMCR, CRM, OPEN. I mainly short using bear call spreads to collect premium from option time decay