Themarket is flashing big warning signals right now.
The biggest concern is the Federal Reserve tapering its
quantitative easing program. The impact of the world's most
powerfulcentral bank reducing the size of its monthlybond
purchases cannot be overstated. An official announcement on
taperingwill most likely have a huge effect on the market.
Second-quarterearnings also came in weak, with headliners like
Microsoft (Nasdaq: MSFT)
falling short of expectations and voicing weak forecasts.
That fundamental weakness went on to triggermultiple sightings
of theHindenburg Omen , considered one of the mostbearish
technical indicators in the market with a strong history of
predicting pullbacks and corrections.
Any of these events on their own would be worrisome and good
enough for a weak patch in the market. But all three together,
while the market trades with a relatively high valuation near the
all-time high, has investors on edge.
If the market falls,overvalued small-capstocks will be the
most vulnerable. And there is onestock from this group that will
be particularly vulnerable to losses in a broad
This company has cashed in on the popularity ofreal estate as
anasset class in the past 10 years and went public two years
ago.Shares had been mostly flat before skyrocketing to a new
all-time high and 195%gain thisyear .
I'm talking about
Zillow (Nasdaq: Z)
, the popular online real-estate services specialist.
While those are solidgains for Zillow investors, thatbullish
move on the chart hasn't been matched by earnings or earnings
growth projections. In fact, Zillow has no earnings at all -- in
fact, the company is expected to lose 63 cents a share this year
and 3 cents in 2014. Although that's big-time progress toward
achieving profitability, it makes Zillow's $85 share price one of
the most overvalued in the market and vulnerable to a sharp
decline on any weakness in the S&P 500.
But it's not just potential weakness on the chart that Zillow
investors should worry about. The company is also suffering from
the high cost of growth. Zillow plans to double its spending
onsales and marketing in 2013, jumping to $100 million. That $100
millioninvestment is expected to increaserevenue 60% to
management's projected $187 million in 2013.
If the cost of increased sales comes at the expense ofmargin
strength, then thescalability the company is banking on to become
profitable is at risk. Those diminishing marginal benefits are
the same problems that took
Groupon's (Nasdaq: GRPN)
shares from $25 at its initialpublic offering to $2.69 before
Zillow will also be battling a highly fragmented and regional
market, intense competition and an industry with very few
barriers to entrance. This sounds like the antithesis of
theWarren Buffett investment philosophy , which is to invest in
market leaders in established industries with high barriers to
entrance that limit new competition.
Risks to Consider:
Zillow continues to see impressive growth in online traffic
and premium subscription rates. Although earnings still remain
negative, the company is expected to become profitable in 2015.
Zillow is also one of the hottest momentum stocks on the Street,
which means it can trade with high valuations for extended
periods of time.
Action to Take -->
The market has been flashing warnings signals, withthe Fed taper
and Hindenburg Omen fueling fear of a sell-off on the Street.
That would weigh on all segments of the market, but overvalued
small caps will be hit the hardest. And Zillow is one of the most
overvalued small caps in the market. Although Zillow continues to
see impressive sales growth, the company is years away from
turning aprofit . And with shares trading near a fresh all-time
high, there's still time to take profit and avoid a stock that is
particularly vulnerable to a broad sell-off.