by Charles Sizemore | February 10, 2014 12:22 pm
We’ve all been there: a torrid love affair that you know would end badly.
It sure was fun at the beginning. You’d get that little flutter in your chest and your pulse would race whenever you laid eyes on them … and oh, the way they would move. But deep down, you knew it would be a mistake to get too attached. It was never going to work long term.
And it always made you a little uncomfortable to hear the other guys in the office high-fiving and bragging about their own exploits with the object of your affection.
I’m talking about hot momentum stocks, of course. What were you thinking about?
The truth is, the passions unleashed by a momentum stock aren’t all that different from those experienced in a new romance. And in the spirit of Valentine’s Day, I’m going to give you three stocks that look so good … but are likely to break your heart if your commit to them. Trade them if you will. They can make for exciting flings. But whatever you do, don’t marry them.
The first on the list is Netflix (NFLX). As I wrote last month following its earnings release, Netflix is a great company. A revolutionary company.
But at current prices, NFLX is a terrible stock.
Netflix beat last quarter’s expectations in every way a company can beat expectations, increasing its customer base, revenues, earnings per share and even its gross margins more than the consensus Wall Street estimates. The margin compression from increased content costs that many investors (myself included) have feared has simply not come to fruition. NFLX has been able to grow its top line via subscriber growth at a faster clip than its content costs have risen.
What’s more, Netflix has changed the way we expect to watch television. Largely because of NFLX, TV viewers now expect on-demand programming available on any device at any location at any time. Cable TV companies are scrambling to adapt their offerings to match the format of Netflix; most recently Comcast (CMCSA) — America’s largest cable TV provider and one of the biggest Internet providers as well — is now essentially copying Netflix’s format, introducing a “cloud-based” set-top cable box that will let viewers watch their favorite shows and movies on any of their devices.
And herein lies the problem. Most of Netflix’s content is reruns of old programming — programming that NFLX is competing to license with the likes of Amazon.com (AMZN), among others. And given that roughly half of all broadband Internet subscribers already have Netflix subscriptions, it’s hard to see Netflix’s growth continuing at the current pace for much longer.
Meanwhile, NFLX stock sports a trailing price/earnings multiple of 232 times and a forward P/E of 60 based on consensus estimates for 2014 earnings. Again, great company, but if you’re paying 232 times earnings for a company with a growing list of powerful competitors, you’re putting yourself at serious risk of heartbreak.
I mentioned Amazon (AMZN) as being one of Netflix’s biggest competitors. Well, Amazon happens to be everyone’s biggest competitor. If we are to play on romantic analogies, Amazon.com is the young, exotic femme fatal competing against frumpy old maids Walmart (WMT), Target (TGT), Barnes & Noble (BKS) and Best Buy (BBY), among others, for the attention of both shoppers and investors.
Amazon’s evolution as a company has been impressive. It started out as an online bookstore and has evolved into one of the dominant retailers in virtually every product category under the sun.
Skeptics and bears have long called Amazon the “river of no returns” for the company’s focus on sales growth and market share over profitability. Yet bulls have essentially taken the view that the profits will eventually come — when Amazon has crushed its competitors and forced them all into bankruptcy — and it belatedly raises its profits.
AMZN stock trades for a ridiculous 612 times trailing earnings and 84 times expected forward earnings. And this for a company with a return on equity of 3.1% and profit margins of just 0.37%. In contrast, frumpy old Walmart sports a return on equity of 22.53% and profit margins of 3.62%.
Amazon might have a sexier story behind it, but at its heart, it faces the same competitive forces that Walmart and the rest do. Mass-market retail is a cut-throat business with slim margins. There is always someone out there ready and willing to undercut you. And if you invent a better, more efficient system for controlling costs, you can bet your competitors will be copying it in no time.
Amazon’s share price collapsed in late January after a bad earnings report, falling by more than 14%. Yet the correction only took the stock back to November levels. At some point, investors will take a hard look at Amazon’s valuation, and a real heart-breaking correction will follow.
And finally, we come to Tesla Motors (TSLA), the designer and manufacturer of electric vehicles.
Few stocks can match Tesla on pure sex appeal. In an age when it is economically sensible, politically correct and even trendy to be green (how often do economically sensible, politically correct and trendy all overlap?), TSLA is justifiably a stock that gets its share of attention. InvestorPlace’s Kyle Woodley made it his entry in the Best Stocks for 2014 contest, and through early February he’s running away with it. The stock is up 29% year-to-date after more than tripling in 2013.
There’s just one problem. Tesla doesn’t actually make money. TSLA lost $147 million over the past 12 months on revenues of $1.7 billion.
Tesla is expected to turn a profit this year, but investors have long since baked this into the stock price. TSLA stock trades for 117 times expected 2014 earnings and 12 times sales (in the trailing 12 months). As a point of comparison, General Motors (GM) trades for 7 times expected earnings and 0.3 times sales.
I know. Tesla is the future, and General Motors is the past. Except General Motors also is active in both electric cars and hybrids. GM announced last year that it planned to bring to market an electric vehicle that can go 200 miles between charges that costs about $30,000. Tesla’s Model S can go longer between charges — 265 miles — but also costs more than twice as much, at $71,000.
And let’s face it, electric cars are still pretty terrible to drive. Hybrids offer better range and better power and still go a long way towards satisfying modern green sensibilities. The same is true about natural-gas-powered heavy-duty trucks, built using engines built by Cummins (CMI) and others.
TSLA is sexy. But it is priced to break your heart.
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long WMT and CMI. Check out his new premium service, Macro Trend Investor, which includes a free copy of his e-book, The New Megatrend Investor: The Ultimate Buy-and-Hold Strategy That Will Make You Rich.
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