Amid all of the novel-coronavirus-derived madness in the markets, several momentum stocks have risen so fast that they have become overvalued stocks to sell.
Today, we’ll take a look at three of these overvalued stocks. But, before we do, let me make one thing clear. I support the fundamental thesis behind all three and my issue lies only with the short-term price action in each of these stocks. The problem is that they gained too much popularity during the quarantine, and that situation is in the process of unwinding. I would definitely support buying the dips in all three of these stocks to varying degrees of certainty. This is definitely not an outright call to short all of them blindly.
On June 5, the stock market exploded higher because of a completely bonkers jobs report. Experts expected 9 million jobs lost, but instead the U.S. reported nearly 3 million gained. I will personally reserve my judgement until I see the revision next month. My prior life as a former number cruncher leads me to be skeptical of outlier reports. Nevertheless, the rally happened and the shorts got killed. Oddly, all three stocks in focus today we’re down on a massive up-market day and more weakness this morning. Call it coincidence, but I think it’s proof of my concept. If indeed the bottom of this crisis is in, the stocks that were popular during the lock-down should unwind in popularity as we recover.
The three overvalued stocks are:
Luckily for the bulls, all three have had a great ride this year. ZM and SHOP stock are up almost 90%, while W stock is up 2.5 times more. All three can afford a dip without causing Wall Street too much grief.
Overvalued Stocks to Sell After the Quarantine: Zoom Video (ZM)
The use of Zoom’s video services exploded during the quarantine and this makes total sense. Most of us have used it for both personal and work functions. Investors chased the stock into earnings expecting wonders. Management reported last week and they did not disappoint. Zoom’s team blew away all upside expectations, so the fundamentals caught up with the hype. But it’s still up to the company to actually monetize this additional usage.
A lot of the newcomers will continue to use Zoom’s services after the quarantine, but there’s also no doubt that as we physically go back to work, we will need less of it. The honeymoon period of explosive growth has to taper off and settle in a more normal ramp. The company will continue to have good prospects; however, the chart has to normalize a bit. Last week, ZM stock fell as much as 15% from its high on Wednesday into the Friday close. This week, the bulls are still in danger because if they lose last week’s support, they are in danger of losing quite a bit more. They could even fill the gap near $180 per share.
Even then, this would be perfectly normal price action. In fact, it would be good for the bulls in the long run. The $180 per share level marked a major failure late in April, and then served as the breakout point in May. Stocks often need to retest the starting points for footing, so they can build a better base for even higher prices in the future. Forego short-term profits to build a better base; otherwise, it’ll topple easily.
Investors who are looking to buy ZM stock for the long-term are probably not going to worry about plus or minus 4% now. But most of us would rather wait for a 10% dip in the next few weeks to start trades with better odds of green. Otherwise, it is okay missing out on a few upside bucks from here. I am also reserving judgment as to how well management will be able to monetize the users. I, for one, will not pay for Zoom’s services because I have alternatives that are also free. Two of those are services from tech giants Facebook (NASDAQ:FB) and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL). If Zoom forces me to pay, I will stop using it and I bet I’m not alone in this.
Shopify (SHOP)
Shopify is an incredible company and the stock price action reflects it. Think of it as a mini Amazon (NASDAQ:AMZN), only this one doesn’t have the added stress of proving to everyone that they need to transact online. Amazon already blazed that trail over the last ten years, and the quarantine forced the whole world to get on board with the idea. Buying online makes complete sense and is here to stay for the long term. The demand on Shopify’s services is not a fad, it is a strong trend with exponential acceleration.
Management has the confidence vote on Wall Street, so substantial dips in SHOP stock are definitely buying opportunities. This is the point of today’s write up on all three stocks. After an incredible rally, the bulls rested and the stock dropped as much as 17% into Friday. If SHOP loses the low from May 27, it could retest $645 per share. This would not be the end of the world because that was the pivot zone from which it based the entire 40% rally from April.
I see a great stock for a long-term investment, but it’s also one to buy on dips rather than chase rips. Since they don’t ring bells at tops and bottoms, some investors always prefer getting in now and to those I would suggest taking partial positions just in case. Sometimes the problems come from outside. Negative stock situations are often completely extrinsic to Shopify. Meaning, the stock market is so far extended ahead of its skis in general that it too is in danger of corrections. A small trip could cause momentum stocks like this one to fall faster than the indices. So even though the story for SHOP stock is still strong, there’s added risk from the macroeconomic conditions.
Wayfair (W)
The rise of Wayfair’s stock price was awe-inspiring. It rallied almost 800% from the $20’s to almost $200 in just a few weeks. Short squeeze or not, kudos to management for pulling off this feat. The marketing team is doing a great job because I recently landed on their website while shopping for an air conditioner. While I didn’t buy my A/C there, they had the opportunity to earn my business on a sell-through.
However, an insane rally in W stock like this needs to time for investors to digest. This can only happen with temporary dips. It is important to note that W stock has already corrected 25% once and bounced. It’s on its way back down to retest the footing perhaps for a second time. While it had enough time to chop around, I don’t think it was substantial enough to consider buying this small dip.
The better bet is to wait to see for the potential test the $160 zone. This sounds like it’s miles away, but it was $120 about a month ago. The price action you’ve seen in the stock market recently is not normal and W stock is a prime example of it. Some sanity has to come back regardless of how good the story is here. Once again, this is nothing against Wayfair’s fundamentals because the company seems like it is firing on all cylinders. I like Amazon stock and I would have the same opinion of it after similar price action.
I’m just not a fan of chasing hype, which should explain my skepticism today. There will be better times to get into these great stocks in the making. They are not cheap and even then, this is a not a deal-breaker for companies trying to grow this fast. In fact, it’s a prerequisite that they be expensive because they have to spend a lot in order to grow a lot. But it also means that there is a lot of fat and if something goes wrong in the economy, fat is what they sell first.
One jobs report does not make for a healthy economy and we are so far from that it is scary. Sentiment is a powerful motivator as demonstrated on Friday with a huge rally across all indices and almost all stocks. But that is a knife that cuts both ways and people quickly forget how bad sentiment was during the March crash. While I am not calling for a repeat of that, it is a recent example that should still serve as some sanity here on the way back up.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.
