3 Overvalued Stocks to Avoid at These Levels

overvalued stocks - 3 Overvalued Stocks to Avoid at These Levels

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Today’s note is more about caution than exuberance, as we look at these three overvalued stocks. Ultimately I am bullish on all three of them, so this is short-term caution.

In other words, all three are eventually a buy — but at what levels is the question.

Year-to-date the S&P 500 is up under 10% yet this bunch is up over 150% — sometimes well over 200%. Apple (NASDAQ:AAPL) is arguably the best company on the planet, nearing $2 trillion in market capitalization, and it’s only up 53%.

First of all, “value” is not what I seek in a growth stock, so I am not expecting them to be “cheap.” But there is relative value to their own prior levels that we have to consider. They are momentum stocks, so we know that they move fast — and therein lies the problem. They have moved way too fast and some are starting to show cracks. The RobinHood effect is exacerbating this matter a lot.

There is a hoard of newer traders who have not been through all cycles of a stock rally and they are voraciously buying any burst like they won’t see another rally again. The FOMO (fear of missing out) is in top gear but what these fairly new investors may not realize is that it’s a knife that cuts both ways. They’ve yet to suffer enough of the carnage that can follow super spikes.

The trick for investors now is to not get caught up holding the proverbial bag, but rather pounce on the opportunity when it presents itself.

The three overvalued stocks that we discuss today are:

  • Zoom Video (NASDAQ:ZM)
  • Shopify (NYSE:SHOP)
  • Twilio (NYSE:TWLO)

Overvalued Stocks to Avoid for Now: Zoom Video (ZM)

Overvalued Stocks: Zoom (ZM) Chart Showing Entry Point
Source: Charts by TradingView

I will start with the stock I used the most — but I liked the least at its highs, mainly because the buyers took it too far, too fast. I don’t use this statement often, so I really mean it when I do. My issue is with its relative premium that the bulls assign it versus other expensive stocks. For example, Zoom’s price to sales is almost 20 times that of Amazon (NASDAQ:AMZN).

Notice that I didn’t mention the 1,500 price-to-earnings ratio because I don’t expect it to be profitable, I just need realistic growth expectations of its future sales.

Investors who buy ZM stock today agree to pay 110 years worth of sales in one shot up front. That is an extremely high mark to hit. Now the stock has corrected 7%, but it still is too high because it is only 9% off its all-time high.

There is no doubt that Zoom benefited from the quarantine and that is evident from their user reports. They crushed user growth expectations but therein lies risk. Until they convert them to paying customers, the new usage will be a drag on resources and costs. Most users I know will not pay to use ZM especially that there are so many other free alternatives.

I bet that Zoom will eventually be a successful business model, because the whole world is now convinced that it’s a smart way to meet. Perhaps they can monetize the corporate clients more effectively than the retail users, and even then they are not the only gig in town. Their competition includes companies like Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) and Facebook (NASDAQ:FB) so it won’t be a monopoly for them.

I am not bearish on Zoom Video — I am bullish from lower levels. I see better entries near $180 per share. There is support just below current levels, but ZM stock is vulnerable for dips thereafter. Conversely, if the bulls can go above $276 then they can rekindle technical interest and have a chance at retesting highs.

Shopify (SHOP)

Overvalued Stocks: Shopify (SHOP) Chart showing Entry Points
Source: Charts by TradingView

Amazon laid down the blueprint, and Shopify is building its own empire from that foundation. This Canadian company is extremely successful at what it does, so it gained notoriety pretty quickly. Wall Street is confident in the management team as they continue to execute well on plans. Although it is not a cheap stock with a price-to-sales ratio of 78, they have delivered the growth to justify some of the premium.

However, this builds downside risk — but one that needs a trigger. Either the company has to err or the stock market in general has to crash for SHOP stock to correct. If and when this happens, it will be swift and painful because the chart is now a very sharp rising wedge and this is not a clear point of entry. However this is almost always the case with momentum stock like this.

Those who believe in it for the super-long term need to just plug their nose and own it. The only defense against high stock prices is to take new positions in small bites. Taking full-sized positions all at once near all-time highs leaves little room to manage risk. So far, $960 per share has held well enough, but it is definitely not bullet proof. There is much better support near $825 and $735 per share and investors should pounce there when the opportunity presents itself.

2020 has been a tough year for everyone, but it’s been a great year for frothy momentum stocks — especially this one. As people locked themselves in their homes they’ve needed to migrate their businesses and shopping online. This played perfectly into Shopify’s hand.

My caution today is not an insult to Shopify. Its stock needs a rest so that the fundamentals catches up with the Covid-19 burst. In time, the profit-and-loss statement will mature and investors will have better conviction even through tough times. Amazon did it before and the critics lost fortunes shorting it. Long term, this overvalued stock is a buy but it is better to buy on the dips.

Twilio (TWLO)

Overvalued Stocks: Twilio (TWLO) Chart showing Entry Points
Source: Charts by TradingView

The price action in TWLO stock this year has been emblematic of the overall risk appetite in equities. The economic conditions are terrible, and it should have made stocks like this toxic. Instead investors are flocking to it. Last week was the first in a long while that it showed some persistent weakness. This is a concern. If Twilio stock stops getting a bid, maybe this bull market is tired and ready for a correction.

Like the other two stocks, this one is worthy of the risk because of future potential but it’s best to wait out for better entry points. There is no doubt that the management team earned the respect of Wall Street, but all stocks eventually need rest. There already is a rotation trade going on between the small caps and the Nasdaq. Eventually there will be a similar one between high beta stocks like this and more stable equities. So far the investors are buying the dips in TWLO stock faster than normal to the point that there barely qualify as dips.

Patient investors may have a better point of entry below $190. If the buyers return this week, then it may be able to continue this higher-low trend that started in March. If for whatever reason they fail to buy the $236 level, then TWLO stock could find sellers and test $200. These would be good opportunities to buy the dip, but the best one would be $20 lower.

While this seems crazy, such frothy stocks carry low conviction on bad days. TWLO is the cheapest of the three today by far, and yet it has 30 years worth of full year sales built into its stock price today. If trouble comes there is little intrinsic defense against the corrections.

Today’s stock are very loved so I am sure my readers are apprehensive about my bearish tone. But in reality I do like how strong they are. I only suggest picking better investment entry points in these oversold stocks.

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.

Article printed from InvestorPlace Media, https://investorplace.com/2020/08/3-overvalued-stocks-to-avoid-at-these-levels/.

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