In the final stages of the dot-com boom, a number of stocks
tacked on stunning gains day after day, in what's known as a
"melt-up." These stocks were no longer logically valued on any sort
of fundamental basis, and instead were squarely in the hands of
momentum investors that know a happy stock chart when they see one.
I've been looking at three companies that looked fairly pricey a
month ago, and now they're much more expensive today. You'd be
crazy to buy these stocks now, and with a strong stomach, you're
likely to make a tidy profit if you're willing to go against the
tide and short them.
Netflix (Nasdaq: NFLX)
I thought this company lookedovervalued at $170 in late
October. A month later, itsshares have breached the $200 mark. And
at that price, it's unclear what investors think they're getting.
If you assume that
cash flow
for this video rental firm can grow +25% annually in the next five
years, then you're looking at around $670 million in cash flow by
2015. The stock trades for around 15 times that figure. Find me
another stock that trades for 15 times projected 2015 cash flow.
There aren't any. And that +25% annual cash flow growth forecast
implies that Netflix will keep finding more and more customers and
more than double its revenue base in the next five years. That's
the kind of logic that fueled tech stocks in the late 1990s, and we
know how that turned out.
This is a great company with more growth ahead of it, but investors
have simply gotten carried away. One bad quarter and Netflix could
turn out to give back its +100% gain that it has posted since this
summer. That's -50% potential downside.
Chipotle Mexican Grill (Nasdaq: CMG)
In a similar vein, a huge number of investors are piling into
Chipotle Mexican Grill, pushing itsshares past $100 in February,
$150 in June, $200 in October, and $250 in the last few trading
sessions. It has "gone vertical" as the trading pros like to say.
Yet at $250, the stock is no longer connected to any sort of
fundamental logic, trading at roughly 40 times next year'searnings
, even asearnings growth is starting to slow.
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Chipotle has recently extolled expansion plans that could take
annual revenue to $3 billion by 2014 and
earnings per share (
EPS
)
to $10. Trouble is, that implies +15% to +20% sales and profit
growth, hardly the kind of growth that justifies the stock's
current scorching valuation.
Up until now, Chipotle has done a very impressive job of
establishing a reasonable bar and then exceeding it. That worked
fine while most analysts played the wait-and-see game with their
estimates. Nowadays, the bar is set much higher as analysts seek to
more accurately forecast the robust quarters to come. And that
could be trouble as momentum investors own this stock for its habit
of handily exceeding forecasts. Delivering quarterly results that
are merely in-line with forecasts would likely be met with a harsh
reaction by the mo-mo crowd that has been able to already post
sharp gains in this name.
With the exception of the week of November 8,shares of Chipotle
have finished every week with a gain since August 9. The key here
is to watch those gains start to cool. If and when Chipotle's chart
starts to move sideways, you'll know that buyers are fatigued. And
that will be great time to either book profits if you own it or
shortshares if you are looking for a downside play.
Realistically,shares deserve to trade at about 30 times next year's
profits, which implies a -25% downward move.
Salesforce.com (
CRM
)
November has been awfully kind to this purveyor of software that
helps to track sales leads.Shares , which had already nearly
doubled this year, surged from $110 in November to a recent $141.
That's a +20% move in just eight sessions.
You can understand why investors have always loved this name: sales
grew at least +40% every year from 2002 to 2009. These days, sales
growth looks set to cool to around +25% in the year ahead. The
bottom line
is cooling as well, as per share profits are likely to grow around
+25% in thefiscal year that begins next February. The fact
thatshares trade for an eye-popping 90 times projected fiscal
(January) 2012 profits should give you pause.
Why such a lofty valuation? For starters, investors bandied the
company around as a takeover candidate this summer, though the
current $18 billion
market value
now makes that much less likely. Second, the company is seeing
solid interest for its new "Chatter" software, which is a
Facebook-like feature that works with the company's customer
relationship management software. Chatter doesn't add to revenue,
but it does help to retain customers that may think about
defecting. Third, the company just delivered a very robust quarter
and is firing on all cylinders. Fourth, CNBC's Jim Cramer keeps
saying "buy, buy, buy" on his TV show, and that's what his loyal
followers are doing. (A whiff of the Pied Piper if you ask me…)
As is the case with the Netflix example cited earlier, you'd have
to make some pretty heroic assumptions for Salesforce.com's
free cash flow
growth in the next five to 10 years just to simply justify the
current share price, let alone make a case for any upside. This is
a very good company, butshares do not deserve to trade at 90 times
next year's profits and 10 times trailing sales. The free cash
flowyield is around 2.5%, which makes it very hard to make any sort
of case for solid returns from here.
Action to Take -->
Netflix, Chipotle and Salesforce.com are all extremely vulnerable
to profit-taking. As I said earlier, you'd be crazy to buy these
stocks now. And if you hold any of these names in your portfolio,
consider selling. Fast.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.