3 Highly Overvalued Stocks Ripe For Shorting

Includes: AMZN, CRM, IWM
by: Hedgephone

The stock market is overvalued, overbought, and over-hyped right now in my opinion. Margin debt is back to where it was before the last crash, fund flows have not been this robust since just before the crash of 2000, and the market is trading for a price to peak earnings ratio of over eighteen times earnings. It seems the little guy is jumping back into the market from off the sidelines and that now may be the best time in five years to short select overvalued equities.

Here are 3 defined risk ways to "get short" some of the more overvalued names in the market:

Russell 2000 (NYSEARCA:IWM) In the money put options: We like the slightly in the money, front month put options on IWM the best for hedging and risk management purposes right now. This type of trade carries very little in the way of option premium while giving short sellers almost 1 for 1 on a delta basis (meaning you make almost as much as simply selling short if the IWM falls) while limiting your risk.

Salesforce.com (NYSE:CRM) in the money put options: Salesforce.com is a pretty sketchy investment in our opinion. Where else can you pay $23 billion for slowing top line growth, mounting losses, and insider selling that boggles the mind? Look no further than shares of CRM, which are at all time highs right now. While the bubble could grow from here, the likelihood of reality hitting these shares over the long run is substantial. We think the stock is worth around $100 or so, but putting an objective price target on something that trades based on pure emotion like CRM is a tricky exercise. As others have highlighted, Salesforce produces losses not earnings so a PE ratio analysis is less relevant. That said, this stock reminds me of the late 1990's more than anything else.

Here is a link to the correspondence, filled with goodies about accounts receivables, changes in working capital, and deferred revenues.

The SEC correspondence on cash flows, deferred revenues, accounts receivables, and working capital points to major red flags. Salesforce touts "free cash flow" in their earnings releases but most of the company's operating cash flow comes from increasing short term liabilities or changes in working capital and not earnings or depreciation. Changes in working capital can be manipulated to give the appearance of robust cash flow growth when in reality a company is bleeding money.

In my humble opinion, the SEC has finally caught on and warned Salesforce not to be so promotional regarding cash flow and growth presentations in the future. Even though the SEC found no reason for taking action against the company, investors should read between the lines on CRM's cash flow statements. A good way to look at operating cash flow for most businesses is the "Owners Earnings" method developed by Warren Buffett which adds depreciation to net income and subtracts capital expenditures. By this metric, CRM made around $100MM in operating cash flow over the last twelve months but spent $181MM on capital expenditures, meaning the company lost around $81MM on a free cash flow basis. Basically, the company has produced negative, not positive free cash flow growth over the last few quarters as increasing revenues have simply been eaten up by higher selling costs and increased overhead.

While Salesforce is an awesome business, we think it makes for a horrible investment because the stock is held up by "air hooks" and not earnings. Valuations here just don't make sense -- why anyone would pay $24 billion for a company losing $81MM is beyond me. While I could get into the whole argument regarding their corporate headquarters being too lavish, or other "morality judgments" I will spare my readers here. Just look to short this stock once the overall market rolls over -- CRM is a beta factory (1.4 Beta) and it should drop more than the overall market when stocks move down just as it outperformed briskly on the way up. If there were ever a "perfect stock" that momentum traders dream about, it's Salesforce. Just remember that sometimes gravity works in the stock market when things move up too far too fast (note a chart of AAPL which we urged investors to short or sell on March 22, 2012).

Amazon.com (NASDAQ:AMZN) In the Money Put Options: It's a decent time to be short Amazon.com via put options, especially after the post earnings run-up in our view, because the recent parabolic move in the stock does not make sense given the fact that AMZN is generating heavy losses and no profit. Amazon faces a whole array of headwinds including market saturation, the law of large numbers (which is why Apple was crushed -- they are simply too big to grow), and state sales taxes which are inevitably going to hurt Amazon's competitiveness over the longer term. If you think Apple was a bubble, just check out AMZN as the latter has literally zero in the way of earnings. At least Apple had a PE ratio! We think the AMZN Feb. $300 put options are a good way to get some short exposure on Amazon without paying huge option premiums or risking potentially unlimited losses that come with shorting stocks directly. If you thought Amazon was overvalued before the earnings announcement, you should love the set up for the short side even more after the post earnings jump.

Disclosure: I am short IWM, CRM, AMZN. 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.