Cloud stocks and tech stocks have outperformed in 2020, despite all the uncertainty. There was the spike in volatility back in March 2020, then the massive stock market sell-off (and the even more remarkable stock market rally) in the months that followed. And then there’s the coronavirus pandemic, an external factor nobody could have predicted.
But are cloud stocks also in danger of a rapid sell-off and a dot-com bust? The answer with simple words is yes, at least for the stocks mentioned below.
If you remember the dot-com bubble back in the late 1990s, it was caused by the excessive or extreme speculation in Internet-related companies. And right now, cloud stocks seem to be on the verge of a dot-com bust based on the disconnection between their stock prices and their valuation. Yes, these cloud stocks below have experienced massive growth. But for savvy investors, the distinction between a great company and a great stock — with emphasis on valuation — is of paramount value.
These cloud stocks have seen their stock prices grown too far, too fast due to the technological boom caused by the Covid-19 pandemic in recent months. Covid-19 caused a huge demand for remote work management and enterprise solutions. This shift to remote work has led to a boom for cloud computing stocks. What makes these particular cloud stocks seem very vulnerable to a potentially huge price decline are the following arguments:
- Most of these stocks are unprofitable
- Their stock price is disconnected from their stock valuation
- The FOMO (fear of mission out) effect has artificially inflated their stock price to astronomical levels
- Fundamentals in terms of free cash flows, margins, financial ratios do not support their valuations related to capitalization
- Expectations for growth are too optimistic and mostly unsustainable
The three cloud stocks that I chose for this gallery, I believe, are just trading on thin air. Any earnings miss maybe a catalyst for falling back to earth.
The stocks I chose to focus on are:
Cloud Stocks: Zoom (ZM)
Shares of Zoom Video Communications recently made a record high. The live-video platform, during the coronavirus pandemic, attracted a lot of attention as a digital solution for working and communications.
With a trailing price-earnings ratio of 659, this stock is far from cheap.
While the financial strength of the company is strong, with little debt, the valuation is too difficult to support. It has explosive revenue growth, but for its 2020 fiscal year, it also had an operating margin of 2%, a book value per share of $2.99, and operating cash flow of 60 cents per share. For a company with a stock market capitalization of $148 billion, those numbers are unreasonable.
Any positive news on the Covid-19 vaccine and a return to normality for daily lives and businesses in 2021 might send the stock price to lower price levels as demand for live-video applications can be reduced significantly.
Fastly shares plunged almost 30% on Oct. 15, after the content delivery and edge computing company reduced its guidance for the third quarter, as a result of the weaker-than-expected traffic volume from the social platform TikTok.
Even worse, Fastly also warned of reduced revenue from other customers. I fully agree with the opinion from Bloomberg that “Fastly’s slowdown highlights the precariousness of lofty software valuations. Massive share plunges are the price paid when these businesses fall short of perfection.”
This is a stock with losses for the past three years, and negative operating income for the past four years. And what is even more worrying is the fact of its negative free cash flows for the past four years with no sign of improvement. If a company is not making money from its core business, then it has a severe problem.
Nutanix is another cloud stock that is considered a growth stock. The problem is that this revenue growth has started to diminish for the past two years. In 2018 the year-over-year growth for revenue compared to 2017 was about 37%. For 2019 and 2020 the year-over-year revenue growth were 7% and 5.8% respectively.
And earnings-per-share for 2019 and 2020 were -$3.43 and -$4.48 respectively compared to the EPS of -$1.81 for 2018.
So the main question is, what happens if you cannot turn these revenues into profits for your shareholders? To me the answer is straightforward. The valuation of this stock in terms of market capitalization is too high, and way too far from its intrinsic stock market value. In all, it’s a very risky stock to hold.
NTNX stock has even negative common stock equity for 2020. Negative shareholders’ equity is a red flag for investors because, in essence, it means a company’s liabilities exceed its assets.
On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article.