Companies growing revenue at a high rate can be rewarding investments if the growth isn’t already fully priced into the stock. On the other hand, if high expectations for growth are already priced in, a bad quarterly report can send shares plummeting. The 5 growth stocks listed below trade at lofty valuations and might already be overpriced, or at least fully priced. I have high expectations for 4 of these 5 companies, and think that they will continue to operate well. Nevertheless, I would hesitate to invest in any of the stocks until a more reasonable entry point presents itself. Of course, the stocks could continue to run higher, but I’d rather miss a stock than buy into a potentially overvalued name.
Zynga (NASDAQ:ZNGA) is the mother of all casual gaming companies with many hit games (Mafia Wars, Farmville etc) and a huge user base. Starting on the Facebook platform, Zynga has expanded its offerings to include iOS and Android games and is having a lot of success on these platforms.
The company went public in December of 2011 at a price of $10. Shares have traded as high as $11.50 but have since fallen to about $8.5. The stock is trading at about 115 times trailing earnings with a projected forward P/E of 43. The price to sales ratio is a reasonable 6, with revenues growing at better than 75% last year. The market cap is about $6 billion.
Considering the growth rate, the stock seems to be reasonably valued but the expectations for further growth might already be priced in. Even if the company can come up with some more hit games and continue to grow earnings, the P/E is still on the expensive side-- considering the risks involved. Casual gaming is a hit or miss business in which users tend to have short attention spans and quickly move on to the next hot game. In other words, past success does not guarantee future success.
Zynga is a company and a stock that I will keep an eye on and would like to own at some point. However, at current levels, it’s too rich for my taste. If the stock were to fall into the $7 range I’d be very interested.
As the leader in professional social networking, LinkedIn (NYSE:LNKD) is the dominant player in a very important niche. The business model is sound and the company is already profitable, with the promise of further profits to come. LinkedIn has the all important first mover advantage, and it is unlikely that another company will be able to move into the professional social networking space and disrupt LinkedIn’s business.
Revenues have been growing at more than 100% year over year, but the stock is trading at an expensive 14 times sales. The P/E ratio is an astounding 880 with a forward P/E of more than 120. This shows that a massive amount of growth is already priced into the stock and any earnings or revenue miss could send shares lower.
On a more bullish note, I think the market cap of about $6.3 billion is fairly reasonable for an industry leader like LinkedIn. I expect that in a few years the sales and earnings will grow to justify the price. I also wouldn’t be surprised if the stock rallies on any good earnings reports, and could even return to the all time high of $122 set back in May of 2011. But even with these bullish opinions, I would avoid buying shares at these levels and would hold out in hopes of a lower price. Again, if I miss the stock, so be it, but I’d rather invest with more margin of safety. LinkedIn has a top spot on my watch list for the time being, and I’ll continue to follow the company and look for a good entry point.
Groupon (NASDAQ:GRPN) burst onto the scene two years ago, creating a new market for group coupons and becoming the fastest growing Internet company in history. The company rejected a buyout offer from Google (NASDAQ:GOOG) and chose to stay independent and file for an IPO. The stock debuted at $20 a share, saw a nice initial pop and traded as high as $31 before beginning a downward trend. At the current price of $17.80 Groupon is off the lows of $14.80 set back in late November, but is in a downward trend and could return to those lows in the near future.
Groupon’s revenue growth has always been impressive, but the company is not able to turn a profit on all that revenue and is at risk of burning through the proceeds from the IPO and having to raise money elsewhere. The company has about $243 million of cash on hand but is losing more than $100 million a quarter according to Business Insider.
Of all the high revenue growth companies on this list, Groupon is the one that I’d absolutely avoid. It has a high spot on my list of companies I wouldn’t touch with a ten foot pole and my advice would be to steer clear of this name.
Sina (NASDAQ:SINA), owner of the Twitter of China (Sina Weibo) is an exciting company with a world of potential. Users of Sina Weibo have exploded to about 250 million and Sina is beginning to monetize the tremendous amount of traffic and will likely be profitable in the near future. Sina has also started a virtual currency (Weibi) which could be another source of revenue for the company.
All things being equal, I’d be happy to buy shares of Sina at the current price of about $50-- but all things are not equal. The Chinese government poses a potential threat to all Chinese Internet companies, especially social media companies like Sina. Last month the Chinese government issued a new mandate that all users of social media must verify their real identity. There has also been pressure on Sina to restrict the flow of information that is critical of the Chinese government. These policies and practices could hurt user growth and lead to potential users going elsewhere for there micro-blogging fix.
Shares of Sina are trading far below the all time high of $147 set back in April of 2011, and are currently valued at about 7.5 times revenue. The company has a healthy $742 million cash on hand with almost no debt. Still, despite the solid balance sheet, Sina is not consistently profitable. Due to the risks mentioned above, I’d wait for a better valuation before buying into this name. Sina is a company with huge potential but until some of the risks are more fully priced in I’d keep it on my watch list, not in my portfolio.
Salesforce.com (NYSE:CRM) is a game changing company that foresaw the trend towards online management of customer relationships and towards social media and got in ahead of the curve. The company is growing revenues very well and is aiming for three billion in sales this year. In the first half of 2011 the stock was outperforming but the share price ran way ahead of the fundamentals and the stock has since pulled back to $101 from a 2011 high of $160.
Shares are trading at about 6.4 times sales, and an ungodly P/E ratio of over 4000 according to Google Finance and over 6000 according to Yahoo Finance. Non-GAAP earnings are in the black but when all costs and stock compensations are accounted for, the company is just about breaking even. But the future looks better and the forward P/E is a more sane number of 62.
The company guided for revenue of $620 to $624 in the December quarter but is still searching for a way to increase profit margins and turn the solid revenue growth into solid earnings. Also of concern is that organic growth seems to have slowed and marketing expenses continue to rise, coming in at $465.8 million in Q3 compared to marketing expenses of $311.8 million in the same quarter a year ago.
With unique companies like Salesforce.com the stock deserves to trade at a premium. But again, a lot of good news seems to be already priced in and the concerns about profitability are too big to ignore.
The bottom line is this: I don’t mind missing a stock. If one or more of these companies goes on to outperform in 2012 I’ll be happy for all shareholders and I won’t regret staying on the sidelines. I love growth companies but the names listed above seem to be too risky at these prices, even given the explosive revenue growth. Having a good watch list is important and finding the right price to buy into good companies is a key to successful investing.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.