This market seems to have no shortage of overvalued stocks. Particularly in tech, valuations have reached levels not seen since the dot-com bubble.
Of course, many of those same stocks have been called overvalued for some time — and have continued to rally. It’s important to remember that high multiples relative to earnings or profits (for those companies that even are profitable) don’t alone suggest a stretched valuation.
Investors received another reminder of that fact this week. Zoom Video Communications (NASDAQ:ZM) came into its fiscal second quarter earnings report valued, incredibly, at over 100x trailing twelve-month revenue. Zoom promptly crushed analyst estimates, just as it did with Q1 results. With revenue rising 355% year-over-year, the multiple compressed in a hurry. ZM stock rose 41% on Tuesday.
It’s not just Zoom, either. Investors can look at Amazon (NASDAQ:AMZN), Tesla (NASDAQ:TSLA), or even Salesforce.com (NYSE:CRM). All three stocks have been called “too expensive” for years. All three have continued to not just rally, but lead the market.
Put simply, overvalued stocks are not the same as expensive stocks. As Zoom proved this week, some stocks are expensive for good reason — and even then, not expensive enough.
That’s not to say that this a market lacking in valuation concerns or overvalued stocks. It’s just that investors can’t judge those stocks solely by headline multiples.
Indeed, these four names don’t necessarily look expensive by the standards of this market. But for varying reasons, they look dangerous despite attractive underlying businesses. All could be buys at some point, but these four stocks definitely need a pullback:
4 Overvalued Stocks: Wayfair
It bears emphasizing when it comes to W stock: investors who have written off growth names as “too expensive” often have missed out on big gains. Those who have shorted growth stocks (or most stocks) based on valuation have been run over.
But even with that caveat, and even with a pullback in recent sessions, Wayfair stock looks profoundly dangerous. The company’s leadership in online furniture retail does seem intact, and perhaps unassailable. The novel coronavirus pandemic provides a potential tailwind by shifting the historically in-store shopping experience online.
Even a roughly 3x multiple to sales seems almost reasonable. But it’s important to understand the quality of that revenue. This isn’t a software firm posting gross margins of 80 percent or better. Wayfair’s gross profit in the first half of 2020 was less than 29% of sales.
It’s also not clear how much of the furniture market Wayfair really can take. Brick-and-mortar stores obviously have a key competitive advantage via a lack of shipping costs, as well as services like in-house assembly and delivery.
There’s certainly a viable business here post-pandemic, something which didn’t seem guaranteed when Wayfair was burning billions of dollars in cash in recent years. The concern is whether that business merits a $31 billion market capitalization — or a stock price that’s over 400x next year’s consensus earnings per share estimate.
AppFolio
AppFolio has been one of the many winners in cloud software. The company’s core platform serves property managers primarily for apartments; a legal business provides a modest amount of revenue as well.
Like so many other software stocks, APPF has had a big 2020, gaining 40% year-to-date. It’s that gain that looks puzzling in the context of moves elsewhere in the market.
After all, we’ve seen housing stocks soar. Home Depot (NYSE:HD) and Lowe’s (NYSE:LOW) trade near all-time highs. The same is true of home builders Lennar (NYSE:LEN) and D.R. Horton (NYSE:DHI).
Those stocks are gaining because the market is pricing in a secular, post-pandemic, shift away from apartment living to single-family homes, and from urban areas to rural and suburban markets. That shift would seem to be bearish for AppFolio’s customers — and thus AppFolio itself. Yet APPF stock has roared.
That rally looks a bit shaky. So does valuation: shares trade at 200x next year’s consensus EPS estimate. There’s a good business here, but AppFolio stock needs a pullback.
J&J Snack Foods
It’s not just tech stocks that show questionable valuations. J&J, the maker of SuperPretzels and ICEE beverages, among other offerings, has looked expensive for some time.
To be sure, the stock is cheaper than it was. Shares are down 31% from last year’s highs. But the pandemic is an obvious driver for a company that derives significant sales from arenas, bowling alleys, and other mass gatherings.
And even after the sell-off, JJSF stock hardly looks cheap at 47x next year’s earnings estimate. In fact, it still trades at 27x earnings for fiscal 2019 (ending September).
That’s a multiple that suggests J&J will not only see business return to normal, but over time grow sharply from pre-pandemic levels. That may happen — but it would seem to take several years at least, and potentially a decade or more. Even after the decline this year, JJSF is not priced for that kind of patience.
Churchill Downs
Casino and racetrack operator Churchill Downs is another pandemic victim. The Kentucky Derby will be held this weekend — but without spectators, costing the company tens of millions of dollars in profit. Churchill Downs’ casinos were closed in the second quarter, and will face a multi-year traffic headwind as coronavirus fears persist.
Yet CHDN stock now has gained a whopping 30% so far this year. The reason for the optimism is the anticipated rollout of sports betting across the U.S. That optimism has boosted stocks like DraftKings (NASDAQ:DKNG) and Gan Ltd (NASDAQ:GAN), and brought CHDN along for the ride.
But that tailwind simply doesn’t seem like enough to offset pressures elsewhere. Nor is it clear that Churchill Downs necessarily will be the big winner from sports betting — or even a big winner. The company doesn’t have the same nationwide footprint as its rivals. Its TwinSpires horse racing platform ostensibly gives it a technological edge, but DraftKings and Flutter Entertainment (OTCMKTS:PDYPY) unit FanDuel have far larger established user bases thanks to their daily fantasy businesses.
To be fair, Churchill has established itself as one of the best companies in gaming. Management has found a way to wring out more profits from the Derby each and every year (2020 aside). The casinos, all acquired in the last few years, generally have outperformed peers.
But CHDN stock has rallied through the pandemic and trades at a premium to other brick-and-mortar plays. It’s certainly fair to ask if the rally has gone too far.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets. He has no positions in any securities mentioned.
