In every bull market of my lifetime, tech stocks have been among the market leaders. Technology innovations have improved both our work and personal lives over the last three decades. They have made corporations more efficient and productive, and tech leaders have made their founders and investors an enormous amount of money along the way.
Unfortunately, as bull markets age, technology stocks also become among the most overvalued and vulnerable to permanent loss of capital.
Unrealistic expectations set in and valuation multiples soar to unreasonable levels. In my opinion, unprofitable companies that sell for a multiple of revenues — not profits — that defies explanation are particularly troubling and dangerous.
The following are three overbought tech stocks that all value-oriented investors should avoid.
Overbought Tech Stocks to Avoid: Workday Inc (WDAY)
Workday Inc (WDAY) is a fantastic example of a company that trades for what I think is an unrealistic price. The company has a good product, and I know of several firms that use its cloud applications for finance and human resources that are quite pleased with Workday’s offerings.
But despite beating analysts expectations in the most recent quarter, WDAY still has weak fundamentals, which have stalled investors’ confidence in the stock.
Analysts expect Workday to earn just 27 cents a share next year. Even if they are right, the stock is trading at 284 times anticipated profits right now. Even worse, from a value guy’s perspective, the stock fetches 13 times revenues.
Even with a 50% annual growth rate for earnings, it will be six long years before the current price could be considered a reasonable buy … if we agree with Ben Grahams advice to never pay over 20 times earnings for even the best growth stocks.
Overbought Tech Stocks to Avoid: salesforce.com, inc. (CRM)
Salesforce.com, inc. (CRM) is another stock with a valuation that appears to defy logic and gravity.
Once again, by all accounts it has a good product. I have never used its customer relationship software, but my son has it and swears by it. However, this not a field where there is no competition and there will be obstacles to future growth as other big tech companies compete against salesforce.
Its competition includes giants like Microsoft Corporation (MSFT) and Oracle Corporation (ORCL) as well as the thousands of software developers in incubators and office parks all over the world trying to work out a better mouse trap.
The company is losing money this year and the always highly accurate Wall Street analysts expect it to make $1.33 a share next year. The stock is trading at 63 times expected profits for 2017 and a stunning 10 times total revenues. It will take 4 years of 30% annual earnings growth for the current stock price to look anything like a potential bargain to valuation-sensitive investors.
Overbought Tech Stocks to Avoid: Yelp Inc (YELP)
Yelp Inc (YELP) is a stock I have loved to hate for several years now. I see little-to-no value to the service with the exception of an off-chance desire to exact revenge on an establishment that has made me angry.
YELP has many competitors that also offer reviews of various establishments, and I see nothing unique about Yelp’s core service. The stock has fallen 45% over the last year, and I still think it is ridiculously overvalued.
Although the company may break into the black in 2018 (as long as nothing goes wrong), it will lose money this year as well as next year.
The stock trades for 3.4 times sales and is about a decade away from the point where earnings would justify today’s stock price for a value-oriented investor willing to pay the highest multiple suggested by Ben Graham.
As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities. He is the author of the Banking on Profits newsletter covering the community bank stock opportunity and the Deep Value Report that seeks out undervalued stocks that are likely to survive until they thrive and capture the value effect that has been proven to beat the market over time.
