We run a stock screen that we have named 'The Nosebleed' that filters for the most expensive or richly-priced stocks in the market. The purpose here is to find stocks that are priced so high up in the stands that the air is thin and investors could begin to experience a nasal hemorrhage metaphorically speaking. Of course, terms like expensive and cheap are subjective, but the stocks that filter in the nosebleed section of the market typically exhibit expectations exuberance with the share price bid up with an extreme and aggressive growth premium.
The difficulty in assembling a list like this is that there are many companies that are simply unprofitable in which case they are technically infinitely expensive based on a negative earnings ratio. On the other hand, if we simply focused on the price-to-sales ratio, there are also a number of firms like development stage biotech and exploratory phase junior minors with effectively no revenues that would dominate any such filter. We also want to look at companies with a meaningful market cap and liquidity that represent real trading opportunities. For these practical reasons, we are using some arbitrary filters to essentially narrow the list. Only companies with a near-term expectation of profitability are included; i.e. companies with a positive consensus EPS estimate for the year ahead.
The following filters are applied:
- Market Cap above $250 million
- Forward Price to Earnings (P/E) above 0 (expectation of profitability)
- Forward Price-to-Sales (P/S) above 10
- Forward EV to EBITDA above 30
The results include 43 stocks which are sorted above by the forward price to sales ratio. There should be little argument to the fact that these stocks are at least richly priced. Keep in mind that the data is as of August 6, 2019. The market is currently volatile meaning this list should remain dynamic. The following summarizes the group data filter results.
- 25 of the 43 stocks are in the technology sector, 9 in healthcare as the most well-represented sectors.
- Average forward price to earnings ratio: 192x (median 83x)
- Average forward price to sales ratio: 15.4x (median 13.5x)
- Avg. forward EV to EBITDA multiple: 100x (median 60x)
- Average stock is up 63% YTD (median price return 52%)
- Average revenue growth in the last quarter 37%
- Biggest winner YTD is PaySign Inc. (PAYS) up 229%
- Biggest loser YTD is Illumina Inc. (ILMN), down 2.7%
The Most Expensive Stocks
In terms of pinpointing "the most expensive" stock, there are a few contenders based on which metric deserves a higher importance. Sorted by the current enterprise value to forward consensus EBITDA, Shopify Inc.(SHOP) can make a strong case as the most expensive stock in the market. SHOP currently trades at a 562.8x forward EV to EBITDA, 536x forward P/E, and 24.3x P/S. The company is expected to reach an adjusted EPS of $0.62 this year compared to a share price of $332.67.The market is extremely bullish on SHOP evident by its 140% price gain year to date.
Coupa Software Inc. (COUP) on the other hand has the single highest forward P/E ratio at 1,472x. The company is expected to earn $0.09 for fiscal 2020 which would be its first year of profitability. Alteryx Inc. (AYX) with this top 5 group, looks like something of a bargain, trading at 257x forward earnings; less than half that for MercadoLibre Inc. (MELI) at 513x. Twilio Inc. (TWLO) with revenue growth of 86% in the last quarter is one of the fastest-growing companies in the market.
Top 5 "most expensive." Table by author/data by YCharts
The pattern among the entire group is strong revenue growth which is to be expected since the trading multiples are essentially the market's way of applying a growth premium for the stocks. Within the group of 43 stocks, the average company reported revenue growth of 37% while there is a wide range among these numbers. Universal Display Corp. (OLED) posted revenue growth of 120% with the company supplying screens to Samsung (OTC:SSNLF) representing 40% of sales.
At the other end of revenue growth, is Arco Platform Ltd. (ARCE) which is the only company in the group that reported a decline in revenues, falling 11.4% in the last quarter. The company provides online education in Brazil and as the last earnings press release explains, revenues are based on content created and are not linearly distributed among quarters with an expectation of volatility across periods at this stage in the growth cycle. For the year, the company provided guidance for adjusted EBITDA growth above 35%. The stock is up 113% year to date and trades at 18x sales.
Group quarterly revenue growth. Source: Data by YCharts/table by author.
It's easy to gawk at a stock with a forward P/E of 500x. Honestly, our first thought is to look for a short idea within the group. Playing devil's advocate, how exactly does one justify such expensive premiums? The answer is that you must project optimistic growth assumptions out over long periods and give the company a benefit of the doubt that they will continuously exceed near-term expectations.
For example, if you are certain a company will double earnings over a period, you can claim that the stock is trading at half its current P/E on a forward basis for that fiscal year into the future. In terms of sales and revenues, for the stocks in the group with a price to sales ratio of 10X, the ability to grow sales at a composite annual growth rate of 25% over the next decade implies a 10-year ahead P/S ratio that is near 1x. The idea is that the growth in revenues and earnings will "catch up" to the valuations as the multiples normalize towards Earth in a best-case scenario.
Ideally, you want the denominator of these ratios to climb faster than the stock price. A full valuation will discount these future estimates and with the right combination of inputs and assumptions, an analyst can build a model that makes these numbers work suggesting a stock is at fair value or even undervalued. There's a particular art to high growth investing.
It's no coincidence the most expensive stocks in the market are filled with tech firms particularly in the software application industry. These types of businesses have the advantage of quickly scaling a new product for potentially a global distribution that generates high margins. Assuming most of the companies are still in an early heavy-investment growth phase, the economics can become very attractive with the right product or service. Fundamentally, investors need to understand what the company is selling and make a decision on the strength of that market opportunity and brand momentum. The fact of the matter is that most of the stocks in this group are here for a reason, and investors like what they hear.
Forward-Looking Commentary And Conclusion
We hope the list above serves as a starting point for further analysis. While investment decisions should never be made on the basis of a data point or solely on valuation metrics, we are confident in saying that the stocks here are speculative and otherwise extremely high risk. Buyers and short-sellers should beware.
We have concerns with valuations in the software application industry in particular. Software as a service or "SaaS" has been one of the hottest buzzwords in tech for some time and the exuberance here is unrivaled in any other market industry group. The point above discussing a 25% annual growth rate over the next decade to help justify a price to sales ratio of 10x may be true, but in reality, there are too many unknowns and in most cases, the company will end up missing a step along the way. The software companies in the list above have an average P/S ratio of 18x. Even if these companies can double revenues over the next few years, it's likely they will remain on this list and still be considered expensive. Investors should question how much of the growth story is already priced in and if the upside from current levels is worth the risk.
Disclosure: I am/we are short WING, SHOP. 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.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Investing includes risks, including loss of principal.