Amazon.com (Nasdaq: AMZN)
has been known as the ultimate "story stock."
Investors have been asked to overlook the e-commerce giant's
relatively unimpressive cash flow metrics, assuming that the
company will eventually deliver the bottom-line numbers that
mature companies deliver.
How large is the disconnect? The company delivered an all-time
best $2.9 billion in free cash flow back in 2009 -- and won't
even revisit that peak until 2015, according to Merrill Lynch.
Amazon's $146 billion market value is roughly 50 times greater
than the 2015 free cash flow projection.
To put that in context, a mature company such as
generated an average annual free cash flow of $6.5 billion over
the past four years and is valued at around 10 times that
Of greater concern, Amazon is no longer the only "story stock"
around. The top 10 or 15 Internet stocks have been on such a tear
that they too are increasingly disconnected from any fundamental
The 40% gain over the past six months for the
PowerShares Nasdaq Internet ETF (Nasdaq: PNQI)
is especially impressive when you note it's filled with large
companies that already sported hefty market caps.
So what do these stocks look like in the context of 2014 and
2015 forecasts? The multiples are quite high.
To be sure, many of these dot-com companies are in the midst
of an impressive growth spurt, thanks in large part to the
impressive gains in mobile computing. The rapid growth in
smartphones and tablet computers has paved the way for solid
traction in mobile advertising and mobile transactions.
And it's wise to assume that the heady growth can last at
least a few more years. That's why you need to look at how these
stocks are valued in the context of 2015 projected results. By
then, some of these companies' most impressive growth rates are
likely to be behind them. And on the basis of 2015 forecasts,
it's hard to get a grasp on their stunningly high multiples.
, for example, trades for more than 20 times projected 2015 free
cash flow, making the stock something of a bargain in this group.
I recently argued that the social media giant deserved its solid
second-quarter gains, but it's hard to justify any further
But the real mania is taking place among the smaller dot-coms
LinkedIn (Nasdaq: LNKD)
. Their current valuations are so stretched that investors must
be assuming that these companies will keep growing at a torrid
pace for many years to come, eventually justifying their current
That makes this a good time for a reality check on their
futures. Pandora, for example, will see stiff competition from
Apple (Nasdaq: AAPL)
, traditional radio chains such as Clear Channel, Spotify and
perhaps smaller upstarts we haven't heard of yet. Moreover,
investors are ignoring the profit challenges in this industry.
Pandora is unlikely to generate even $50 million in free cash
flow by 2015.
In a similar vein, my colleague Michael Vodicka laid out
concerns around real estate firm Zillow, noting that the company
is "battling a highly fragmented and regional market, intense
competition and an industry with very few barriers to entrance."
And it would likely be many years before Zillow's EPS appears
reasonable in the context of the current $88 stock price.
The question for investors: Is all of this a redux of 2000,
when the dot-com boom famously imploded? Not for companies like
Google (Nasdaq: GOOG)
Priceline (Nasdaq: PCLN)
eBay (Nasdaq: EBAY)
, as they have strong moats, high levels of recurring revenue,
and the cash flows to back up their cause. It's the smaller
dot-coms that are looking awfully bubbly. Investors appear so
eager to latch on to companies with high revenue growth potential
that they are increasingly ignoring the more sobering margin and
profit structures those companies possess.
Risks to Consider:
As an upside risk, these are high-beta stocks, and a market
surging to fresh all-time highs could take them higher in the
Action To Take -->
Many of these net stocks are now "priced for perfection," meaning
they must deliver stellar third-quarter results, strong enough to
lead analysts to raise their forecasts. These companies simply
can't afford a hiccup, as their nosebleed valuations would prompt
investors to punish them if their earnings fail to measure
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