On September 7th, 2015, when Weibo (NASDAQ:WB) was still trading at $11.87/share, I wrote a bull article entitled, "The Reality No Weibo Bear Wants To Acknowledge." Weibo's stock price has risen by ~97% since my last recommendation on the stock.
But I believe that this might be the time to take profits. This is because of several reasons that suggest a potential pullback. First, Weibo's one-month Relative Strength Index ("RSI") is above the 70 level. A level, which is indicative of an overbought stock with a potential for a pullback. Second, Weibo is currently trading at ~12% higher than its mean Street price target. Third, Weibo's financial indicators have become too expensive relative to its industry average and the S&P 500. Fourth, the acquisition rumors that made Weibo's stock price to surge have not yet materialized.
Because of the aforementioned reasons, I believe that Weibo's stock price is due for a pullback.
The 30-Day RSI Above 70
Weibo Corporation is in an overbought territory. It is in an overbought territory because Weibo's Relative Strength Index ("RSI") has been above the 70 mark since the 4th of April as shown below (the red rectangle at the bottom of the graph).
An RSI above the 70 level is considered overbought and an RSI below the 30 level is considered oversold. Meaning that it is possible that Weibo's stock price has been in the overbought territory for three weeks and might be due for a pullback.
"An asset is deemed to be overbought once the RSI approaches the 70 level, meaning that it may be getting overvalued and is a good candidate for a pullback. Likewise, if the RSI approaches 30, it is an indication that the asset may be getting oversold and therefore likely to become undervalued." - Investopia.
Weibo's stock price might be due for a pullback for several reasons. One of these reasons is based on the correlation of Weibo's stock price relative to the RSI indicator.
Historically, whenever Weibo's stock price has approached an RSI level of 70 as shown below, the stock price has subsequently declined. For example, in September of 2014, June of 2015 and December of 2015, Weibo's RSI was near the 70 level. And in all three cases, Weibo's stock price was followed by a sudden stock price decline as shown by the red lines in the graph below.
Trading ~12% Above Mean Price Targets
An RSI indicator is not meant to be a standalone technical indicator. In this case, the contention that Weibo might be in an overbought territory and maybe due for a pullback is supported by the fact that Weibo is currently trading above Wall Street estimates.
The high RSI level might explain why Weibo's stock price is currently trading at ~12% higher than its mean Street price target of $20.46/share. As of 04/27/2016, Weibo's stock price traded above its high price target of $24/share.
Trading at the higher end of estimates might signal an overvalued stock that is about to start a downtrend.
Expensive Relative to Its Industry And The S&P 500
Besides trading above estimates, Weibo's financial ratios are looking expensive relative to its industry average and the S&P 500. For instance, Weibo's P/E ratio is currently at ~4 times its industry P/E average and ~12 times the P/E ratio of the S&P 500 as shown below.
(Source: Wall Street Estimates from Morningstar - Weibo's Corp ADR Class A) Click to enlarge
Having such high valuations can make sense if Weibo was a cash-generating business with tremendous growth prospects. But the company still has a negative EBITDA. With the exception of its trailing twelve-month net income, Weibo has consistently achieved negative net income.
The Acquisition Rumors
But there is a reason why Weibo is currently in an overbought territory.
Weibo's stock price increased after the speculation that the Chinese titan Alibaba Group (NYSE:BABA) was planning to increase its stake in Weibo. Investors thought Alibaba was planning to acquire the entire company. Alibaba has done that before with the Chinese online video provider Youku Tudou (YOUKU). On October 15th of last year, Alibaba decided to increase their 20% stake in Youku Tudou to 100%. Alibaba ended-up paying $27.60 American depository share, "a 35.1% premium over the closing price of Youku Tudou's stock on October 15th, the day before Youku Tudou announced it had received the buyout proposal from Alibaba, and a 13% premium to Youku Tudou's trading price" after the announcement of the offer.
Therefore, when rumors that Alibaba wanted to increase their stake in Weibo, investors thought Alibaba was planning to outright buy Weibo. The deal could come with an attractive premium. This is why the potential of a deal has managed to bolster investor confidence in Weibo. But the acquisition might not happen anytime soon.
"Given the two parts of the business, one is slow and one is growing very fast, we'll seek the capital markets transaction if there is a good fit but right now, we don't have any plans to do that," he said."
"I don't think there's anything concrete going on here and I think at the end of the day, it's for Alibaba to assess whether there are synergies, not from us," Chao said. "Obviously, if there's anything that's good for the shareholders of the company, we'll consider but right now, I don't think there's anything concrete going on." - Chao, Sina's chairman and CEO of Sina.
But even if the acquisition transpires, the premium might not be that high. This is because when the rumors started, Weibo was trading at $18/share. The stock price is almost 33% higher now.
Weibo is a good business but Alibaba is not going to overpay for it. The company still has a long way to go for it to achieve positive EBITDA.
The RSI indicator, the Street estimates, the relative valuation and the acquisition rumors suggest that this might be a good time to take profits from Weibo. The stock is overbought and might be due for a pullback. Nonetheless, there is potential in Weibo but not at these valuations. There will be great entry points for the stock after the pullback.
Disclosure: I/we 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.