Understanding the difference between a good company and a good stock investment is extremely important when it comes to generating market-beating returns in the long-run. Amazon.com (AMZN), Tesla Motors (TSLA) and Netflix (NFLX) are three great companies with stocks already priced for perfection.
Way back in 2000, Jeremy Siegel wrote an article for the Wall Street Journal warning investors about the dangers of investing in tech stocks.
“Many of today’s investors are unfazed by history — and by the failure of any large-cap stock ever to justify, by its subsequent record, a P/E ratio anywhere near 100,” Siegel wrote.
While many may assume that Siegel was referring to companies like Pets.com and Webvan, he was actually talking about companies like Cisco Systems (CSCO), Yahoo! (YHOO) and EMC (EMC).
These tech giants all emerged as winners from the dot-com group and are all multi-billion dollar companies now. Each of the three companies has more than tripled revenue since 2000.
How have shareholders been rewarded? All three stocks remain down more than 45% since the beginning of 2000.
Just because a company doubles or triples its revenue does not mean that its stock is a good long-term investment.
Amazon.com (AMZN)
There’s no question AMZN is a great company. But the company’s staggering projected growth numbers are no secret, and the market has high expectations for AMZN.
AMZN is currently priced at nearly $720/share. AMZN, much like former tech growth stock eBay Inc (EBAY), will eventually settle into a much lower long-term growth rate. Here’s what the market is anticipating from AMZN once it reaches that point.
Using a modest P/E ratio of 14.5 as a guide, the market is anticipating that AMZN will eventually earn more than $50 per share. With 471 million outstanding shares, that means the market is pricing in roughly $23 billion in annual income.
In the past four quarters, AMZN reported net income of $1.1 billion, meaning that some astronomical growth is already priced into the shares. Even if AMZN delivers on that growth in the next decade, it’s hard to see much upside to its current share price.
Netflix (NFLX)
NFLX is another exceptional company with huge long-term potential. Unfortunately, its share price is already extremely expensive. Rival media giant Time Warner (TWX) currently has a market cap of $59.2 billion on annual revenue of $29.3 billion and income of $4 billion.
NFLX, on the other hand, is currently valued at a market cap of nearly $40 billion even though it’s annual revenue is only about 25% that of TWX. NFLX’s income came in at just $126 million in the past four quarters.
Clearly, NFLX will likely be a long-term success story, but the market made that assumption a long time ago. Where’s the upside?
Tesla (TSLA)
TSLA may be the best example in the entire stock market of investors counting chickens before they hatch. The long-term bullish thesis on TSLA is that its Model 3, which is not expected to come out until late 2017, will ultimately earn TSLA a General Motors (GM)-sized market share of the global auto industry.
The market currently values TSLA at $30.6 billion, about 66% the size of GM. Today, TSLA generates 2.6% as much revenue as GM and has a tangible book value of only 3.1% the size of GM.
TSLA’s current share price (yet alone any potential upside) is based solely on the belief that its takeover of the auto industry is a guarantee. TSLA has been an incredible success story as a company up to this point. But TSLA’s share price leaves investors little room for upside and the company zero margin for error.
Disclosure: As of this writing, Wayne Duggan had no positions in any of the stocks mentioned.
