Stock valuations take into account the earnings of the company and its current growth rates and future forecasts. Some stocks, despite having low earnings and slow growth rates, may reach sky-high valuations. Markets can often sense the hype, but often too late, and we see boom and bust cycles in which these overvalued stocks face sharp declines in the second half of cycles. Here are 6 stocks which have gone way ahead of themselves. We think these stocks will face sharp pullbacks in the future.
Linkedin Corporation (LNKD) is operating a professional network on the internet, connecting professionals from all over the world. It helps people to find business opportunities and plays its role to enhance sharing of knowledge and professional experiences. The company has grown at a very good pace since 2007. It had about 100 million users at the end of March, 2011. Linkedin is threatened by Facebook, Twitter and now recently launched Google+ by Google, Inc. (GOOG), which has gained about 20 million users in its first three weeks.
Linkedin had a successful IPO in May 2011. It went public at $45, and the stock increased about 109% on its opening day to reach a price of $94.25. The current price of the stock is $101.03 with P/E ratio of 1200. The stock has experienced huge upward increases after its June 20 bottom. On June 20, the price was $63.71. The stock touched the level of $109.97 on July 15 with an increase of about 73%. Afterwards, it started to pull back steadily and reached the current price level of $101.73. If we look at the P/E ratio of the stock, it is huge and the growing competition will eventually cause the valuation to come off strongly. Its growth rate over next five years is expected to be 104%, but there is too much uncertainty regarding that figure, which is working off of a small earnings base. In an environment of growing world uncertainty, any scenario that can affect investor confidence in near future will heavily affect LNKD.
Pandora Media, Inc. (P) operates a very successful online radio, providing its services in the United States with help of the Music Genome Project and its playlist. It is facing tough competition from few of its competitors like Google, Apple (AAPL) iTunes, CBS Radio (CBS) and SIRIUS XM Radio Inc. (SIRI).
Pandora Media Inc. went public on June 15, 2005, at price of $16. The price increased to $45 on that day, but later ended up with price of $17.42 with a high market value of about $2.8 billion. It was being considered as similar to a company receiving high valuations during the dot-com boom. This profligacy was noticed by the market and the price fell to a lower price level of $12.16. Pandora Media Inc. has continuously reported negative earnings. In this situation, it becomes difficult to calculate a valid P/E multiple even on a forward basis due to the lack of earnings.
Pandora started to have some recovery recently, near the end of June 2011. After reaching a record high level of $20.04 on July 1, it started to have a mixed display of ups and downs. On July 21, the stock price was at $18.76 and then declined to $15.09. High valuations and its past trends show that further sharp decline can be expected in the future in a scenario of growing global uncertainty and increased competition in Pandora's markets.
Pandora has reached about 100 million users in the music subscription industry. With the solid grip of Spotify in this industry, and online storage solutions from of Amazon (AMZN), Apple and Google, Pandora can face tough pressure in the market. Its stock can have a huge decline in the future.
Melco Crown Entertainment (MPEL) is an owner and developer of casino and entertainment resort facilities. It provides its services through its subsidiary Melco Crown Gaming (Macau) Limited. A positive outlook from its last quarterly report data indicates that MPEL is expected to have an exponential growth this year. Las Vegas Sands (LVS), Boyd Gaming (BYD) and MGM Resorts International (MGM) are its big competitors in the industry. Its competitors have higher returns on invested capital (ROIC) in past five years.
Since the start of the second quarter, MPEL is on the rise. With price of $7.60 at the end of March, it reached $15.73 on July 22. Afterward, it started to have a slight fall and its current price is $15.13. Its P/E ratio is 900 with earnings per share of $0.02. The P/E ratio of 900 indicates its high valuation. The average P/E value in the hotels and resorts industry is 53.10. The overvaluation can cause the stock to fall more than its peers as well as the market in the event that global risk appetite fades away.
Amazon.com, Inc.(AMZN) provides its customers a platform for online shopping and consumer-to-consumer selling of books and electronics, and it also earns revenue from advertising and promotional services. Amazon faces high competition from Barnes & Noble, Inc. (BKS) and eBay Inc. (EBAY). On a competitive basis, Amazon is a clear winner.
If we look at 52-week history of AMZN, we come to know that the price level of $223.90 was its high. Q1 2011 and Q2 2011 show that after reaching some record high levels, the price eventually declined. On February 14, its price reached to $190.42 after an upward move but then started to fall again.
In the industry, the average P/E is 27.52. Amazon's high P/E of near 100x indicates that it is highly overvalued given its quarterly revenue growth rate around 51%. In the present scenario, with such high P/E and past 52-week trends, it remains vulnerable to any dent in the economic and market sentiment. Any malignant situation will affect it more negatively than the rest of the market.
Baidu.com, Inc. (BIDU) provides internet search related services in Chinese language, and it has its headquarters in Beijing, People's Republic of China. Sina Corporation (SINA) and Sohu.com Inc. (SOHU) are its two major competitors. The earnings of the company are expected to grow at an average annual rate of 41.3% over next five years.
At the start of the year, the stock price was $96.53. Afterward, it had an upward trend and reached a record level of about $152.37 on April 26. This price level was followed by a huge fall, and the price of the stock on June 16 was $116.24. BIDU then started to pick up again and it was on its 52-week highest level of $164.36 on July 26. It reaches the current price level of $157.07 after a downward move.
Bidu's P/E ratio is 72. It is high when we compare it to the average P/E in the internet information providers industry average, which is 23.12. Its P/E is more than 3 times the industry average indicating it may be overpriced and highly risky in the current uncertain global economic outlook.
Rosetta Resources Inc. (ROSE) is an on-shore independent oil and gas company in the United States. Devon Energy Corporation (DVN) and Occidental Petroleum Corporation (OXY) are its two major competitors. The growth rate of earnings for the company is expected to be 31%, which is above the industry average of about 19%.
On August 31, 2010, the share price was $19.70. It started to rise and had some sharp falls on its way and reached the record level of $56.82 on July 25. It currently trades at $51.77. Its 52-week history shows some sharp declines after upward moves. Its EPS in Q1 2011 was $0.21 and it was less than forecasts of about $0.29. The current EPS is $0.44, leading to a P/E ratio of 118, which is about four times above Independent Oil and Gas industry average of 26.95. This situation shows that it is overpriced and can face sharp declines in near future.
If we compare the above six stocks, we see that most have very high valuations; way higher than their peers as well as market averages. Linkedin and Pandora Media were the two IPOs that went sky high on their first day of trading. Linkedin and Melco Crown Entertainment have very high P/E ratios given their competitive positions. Pandora also faces tough pressure from its competitors and its stock price does is not justified given the lack of earnings. Stocks of all six companies are overvalued and are going to face a volatile and risky future. Any major disruptions in the market will likely cause these stocks to underperform.