The novel coronavirus-driven economic slowdown triggered a sharp meltdown for equities earlier this year. However, with the Federal Reserve pursuing aggressive expansionary monetary policies, equities bounced back strongly. Some bounced back so strongly that they are now severely overvalued stocks.
The sharp rally in equities is not just liquidity-driven. There are fundamental factors that have taken stocks higher, however, there are several overvalued stocks currently. These are quality names trading at stretched valuations. While these businesses will continue to create long-term value, the stocks are likely to witness relatively sharp correction in the foreseeable future.
I will discuss the four overvalued stocks that are ready for a pullback. Even with a strong business model, these stocks need to be avoided.
4 Overvalued Stocks Ready for a Pullback: Amazon (AMZN)
There are no second thoughts on the point that AMZN stock is worth holding in the long-term portfolio. However, the stock has witnessed a sharp rally in the recent past and I believe some profit booking is imminent.
From a valuation perspective, AMZN stock looks expensive with a price-to-earnings-ratio of 159. Analyst do expect the company’s annual earnings growth to average 24.5% in the next five years. Even if that factor is discounted, its an overvalued stock.
From a long-term perspective, the company’s core e-commerce business will remain a cash flow machine. The novel coronavirus pandemic accelerated the shift to online shipping and Amazon stands to benefit.
Amazon is also attractive considering the company’s strong growth in the cloud business. With international presence, there is ample headroom for Amazon Web Services to sustain high growth.
Overall, Amazon has strong fundamentals, robust cash flows, and multiple earnings growth triggers. However, valuations look stretched in the near-term. A pullback would make the stock attractive for fresh exposure.
From a business growth and innovation perspective, I am bullish on Tesla for the long-term. However, its worth noting that TSLA stock has skyrocketed by 621% in the last year. At a current P/E ratio of 311.1, TSLA stock is indeed expensive. I expect a pull-back from current levels before the next leg of the rally.
Talking about technological advancement, CEO Elon Musk has commented that Tesla is very close to level 5 self-driving technology. This would imply full automation and keep Tesla ahead of peers in the self-driving car segment.
Tesla already has manufacturing facilities in the United States and China. By the end of next year, the company will also have a manufacturing facility in Europe. This will allow Tesla to ramp-up production and reduce manufacturing and logistics cost. Higher EBITDA margin and cash flows will follow. Therefore, the outlook is bright for the company with presence in high growth markets like China.
However, its unrealistic to expect the stock to keep surging higher. A correction at this point of time is likely and heathy. A potential pull-back can be used by long-term investors to consider fresh exposure.
Zoom Video Communications (ZM)
The novel coronavirus pandemic has triggered robust demand for Zoom video calls and ZM stock has gone ballistic. In the last six months, ZM stock surged by 278%.
There is no doubt that the demand for Zoom Video will sustain in the coming years. However, the stock has run ahead of fundamentals in the near-term. At a P/E ratio of 218, ZM stock can be avoided in the near-term.
It’s worth noting that amidst the strong rally, the company has digested some negative news as well. India’s government has told employees to avoid Zoom due to privacy concerns. At the same time, Reliance Jio has launched JioMeet, which competes with Zoom Video. Its important to mention here that earlier this year, Facebook (NASDAQ:FB) invested $5.7 billion in Reliance Jio for a 9.99% stake in the company.
While Zoom Video remains a market leader with ample room for growth, the stock is likely to correct in the near-term. Therefore, any fresh long positions should be avoided at current levels of $270.
In the last year, SHOP stock has surged by 244% and is among the overvalued names that are ripe for pullback. From a valuation perspective, SHOP stock currently trades at an eye-popping P/E ratio of 2,015.
At times, the P/E ratio does not make sense for high growth companies. However, the currently valuation looks too stretched considering the point that the price-earnings-to-growth ratio is 59.8. I therefore believe that investors need to avoid the stock at current levels.
Coming to the business outlook, there is no doubt that the company will continue to grow in the coming years. The pandemic has resulted in growth in online business platforms and Shopify is well positioned to benefit from this change.
Shopify has also been expanding in international markets and that’s a long-term growth trigger. Further, the company’s subscription-based model implies stead cash flows in the long-term. The company’s subscription revenue is trending higher on a sustained basis.
Therefore, SHOP stock is worth considering on corrections. However, current valuations are not sustainable.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.