With the market at or near its all-time highs, a number of
renowned investors and market commentators have been questioning
the market's valuation over the past month or so.
is the latest to grow wary of the market. "In my mind, it is time
to be cautious about the U.S. stock markets,"
he said last week
So how do investors prepare for a pullback? The first group of
stocks to avoid is the momentum names, which trade on investor
optimism, not on the strength of their fundamentals. Stocks that
trade at outrageous valuations are often the first to be sold if
the market takes a turn downward.
Icahn isn't alone in his caution. Fellow billionaire
is short a basket of stocks that trade at outsize valuations.
In a Bloomberg interview earlier this year
, Einhorn hinted that his targets to short include tech stocks
with negligible earnings that are trading above 10 times
Among the stocks that fit this bill are
All three have price-to-sales (P/S) ratios above 15, and all
three appear to be trading on irrational exuberance. Since the
last major pullback in February, shares of TripAdvisor and Zillow
have been on a tear. Twitter is still under pressure after
investors dumped the stock on fears of slowing growth.
The Beaten-Down Social Stock
If the market sees another pullback, Twitter will likely be in
for more pain. Down 15% from its IPO debut last year, Twitter
still trades at the highest P/S ratio of the three, coming in at
28. It also trades at a forward price-to-earnings (P/E) ratio of
145 based on next year's earnings estimates.
Adding to the many unanswered questions about Twitter's
business model, the company still lacks any meaningful
diversification of its revenue, and the competition for
advertising dollars has been heating up. Not surprisingly, market
research firm eMarketer expects Twitter will trail both
in mobile ad revenue growth this year.
Twitter's revenue has instead relied on expanding its user
base and increasing user engagement, which slowed in its most
recent quarter. The rise of other social networks may only put
further pressure on Twitter's growth.
Solid, But Poised For A Pullback
At the end of April, I noted that TripAdvisor was the
only momentum stock that investors should own
. Shares are up over 35% since then, compared with the S&P
500 Index's 5% gain. However, TripAdvisor may be one of the
momentum names that feels the most pain in a pullback.
It is the only one of these three companies with positive
earnings, but its P/E and P/S ratios are still high at 72 and 15,
respectively. The company relies more heavily on ads than
bookings, which are the focus on
business models. Like Twitter, TripAdvisor is seeing increased
competition in the ad space, and the broader shift toward mobile
may mean less ad revenue for the company, given that mobile ads
are proving less effective than desktop ads.
The Highly Shorted Real Estate Play
Zillow is heavily exposed to real estate sales and has been
benefiting from the resurgence in homebuying. If the housing
market recovery has already played out, it's not just
homebuilders that will feel the pressure -- side plays like
Zillow (and its online real estate database service) likely will,
Jeffrey Gundlach, the CEO of investment management firm
DoubleLine, is one of the market's biggest bears on the housing
market. He noted at
this year's Sohn Investment Conference
that single-family housing is overrated. He also pointed out that
a small rise in rates earlier this year has already hurt the
housing market, and further increases will likely further weigh
on home sales.
What's more, short-seller research firm Citron has been
pointing out Zillow's flaws for a number of years. One of its
criticisms has been that Zillow has been spending too much on
sales and marketing to rev up sales. In one report last year,
Citron asked: "Zillow spent more getting revenue than the revenue
itself. Is this a business?" Between its 2013 and 2014 fiscal
years, Zillow increased its spending on sales, general and
administrative (SG&A) expenses by $14 million -- but its
revenue rose by only $8 million.
With a P/S ratio of 23 and a forward P/E of 155, Zillow
remains one of the most shorted names in the market, with a
short interest ratio
of nearly 32%.
Risks to Consider:
These momentum names could well run higher before seeing a
sell-off. Twitter has already been beaten down quite a bit, and
it could attract growth investors if it posts solid growth
numbers in its next quarter. TripAdvisor is adding subscription
revenue to its business, which could decrease its reliance on ads
more quickly than expected. Zillow could also expand its rental
business faster than expected and capitalize on the shift from
buying to renting.
Action to Take -->
Sell (or short) these 3 stocks before the inevitable market
pullback. All three trade at high valuations and will likely be
among the first names that investors dump during a
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