Whenever I am talking about overvalued stocks that are still worth buying, I go back to Tesla (NASDAQ:TSLA). In December 2019, Morgan Stanley opined that TSLA stock was likely to correct by 40%. Over the next one-year, the shares surged 730%. Further, in December 2020, JPMorgan opined that TSLA stock was “dramatically” overvalued. Nearing the end of that month, the stock price was $695 a share and touched a high of $900 in January 2021. Of course, the stock has corrected in the recent past. However, returns are still flat for 2020 year-to-date.
My here is that seemingly overvalued stocks can continue to run higher, particularly if the business has multiple growth catalysts that are supported by industry tail-winds.
So, let’s talk about seven stocks that seem overvalued. However, some exposure to these names makes sense. Even at current levels. Given the growth potential in these businesses, the stocks can surprise on the upside.
- Square (NYSE:SQ)
- Sea Limited (NYSE:SE)
- Chipotle Mexican Grill (NYSE:CMG)
- Bumble (NASDAQ:BMBL)
- Riot Blockchain (NASDAQ:RIOT)
- Roblox (NYSE:RBLX)
- Pinterest (NYSE:PINS)
Overvalued Stocks Still Worth Your Money: Square (SQ)
Square would certainly be in the list of overvalued stocks, with a forward price-to-earnings ratio of 196. However, there might be a strong case to justify premium valuations. In the recent NASDAQ correction, SQ stock sharply declined from $283 to $200. However, the bounce-back has been strong and the stock currently trades at $242.
Specific to the company’s business, there are multiple growth triggers. The Cash App has reported strong growth in active users. For 2020, Cash App had 36 million active users, which was 50% higher on a YoY basis.
It’s worth noting that Cash App revenue (excluding Bitcoin revenue) was $1.4 billion with a gross profit of $1.1 billion. Clearly, the segment has robust gross margins. As the number of Cash App users increase, the segment is positioned to deliver strong cash flows.
Furthermore, the company’s seller ecosystem also generated $1.5 billion in gross profit for 2020. The segment growth is relatively muted. However, the company has a big addressable market estimated at $85 billion in the U.S. It’s therefore likely that the segment will continue to grow at a steady pace and contribute to cash flows.
Another bullish trigger is the company recently commencing banking operations. The segment is unlikely to have an immediate impact on growth. However, over the next three to five years, banking operations will be among the revenue and cash flow growth catalysts.
With these factors, SQ stock looks interesting. Even at premium valuations.
Sea Limited (SE)
SE stock is another interesting name that has surged by 465% in 12 months. Sea Limited provides investors with exposure to the high growth internet economy of Southeast Asia. With the company’s robust top-line growth, the stock remains attractive even when it looks overvalued.
For the fourth quarter of 2020, the company reported revenue of $1.6 billion, which was 101.6% higher on a year-on-year basis. The company also managed to report positive adjusted EBITDA of $48.7 million.
An important point to note is that for 2020, the company reported an adjusted EBITDA of $2.0 billion in the digital entertainment segment. However, in the e-commerce segment, the adjusted EBITDA loss was $1.3 billion. Similarly, the digital financial services segment reported an adjusted EBITDA loss of $511 million.
A key stock upside trigger would be operating level profits in the e-commerce and digital financial services segment. Even if EBITDA losses narrow, SE stock is likely to trend higher. It’s also worth noting that for the current year, the company is expecting e-commerce top-line growth of 112.3% on a YoY basis. Given this growth trajectory, I am bullish on the company achieving operating level profitability across segments.
Overall, Sea Limited is an established player in the high-growth Southeast Asian internet economy. Once cash flows accelerate, the stock is likely to command higher valuations.
Chipotle Mexican Grill (CMG)
At a forward P/E of 63.2, Chipotle stock is among the overvalued names in the restaurant business. However, it’s worth noting that the stock has remained resilient at higher levels. From a technical perspective, CMG stock has consolidated in the range of $1,300-$1,500. I see strong technical support for the stock in this range.
A key reason for the stock sustaining at higher levels is the company’s growth. Even amid the negative impact of the pandemic. For 2020, Chipotle reported a 7.1% increase in revenue to $6.0 billion. Importantly, digital sales surged by 174.1% and accounted for 46.2% of total sales. It’s likely that digital sales will continue to support growth.
At the same time, Chipotle opened 161 new restaurants in 2020. Even for the current year, the company is targeting 200 new restaurant openings. These new restaurant openings will accelerate top-line growth once business returns to normal. The vaccines provide significant hope in terms of controlling the pandemic. At a time when consumers are increasingly health conscious, a healthy menu offering is another growth catalyst for Chipotle.
From a financial perspective, Chipotle reported cash and equivalents of $1.1 billion as of December 2020. Further, operating cash flow for 2020 was $663 million. The company therefore has strong financial flexibility for growth.
Women-first dating app Bumble, which was recently listed, is another name among overvalued stocks that’s still worth considering. BMBL stock currently sports market capitalization of $8.5 billion.
Recently, the company announced 2020 results and the guidance for the current year. The company expects revenue of $721 million for 2021. Therefore, the stock is trading at 11.8 times forward sales.
Markets might continue to overlook the valuation factor considering the company’s growth. For 2020, the company reported total paying users of 2.7 million, which was higher by 35% on a YoY basis. As the number of paying users increases along with growth in average revenue per user, the stock momentum is likely to remain positive.
Another important point to note is that as the company guided revenue of $721 million, it also shared adjusted EBITDA of $175 million. This would imply an adjusted EBITDA margin of 24.3%. It’s very likely that margin will continue to expand in the coming years.
A key reason is sustained growth in average revenue per user. Further, as the company’s visibility increases, the cost of new user acquisition will decline. This positions Bumble for significant growth in cash flows in the next few years.
Riot Blockchain (RIOT)
After surging by 8,700% in the last year, shares of Riot Blockchain do look overvalued. However, given the positive momentum in Bitcoin (CCC:USD-BTC) coupled with wider adoption of cryptocurrencies, it seems like the RIOT stock rally will sustain.
Riot Blockchain is in the business of cryptocurrency mining with a focus on Bitcoin. The company mined 730 newly minted Bitcoins in the first nine months of 2020. For the same period, the company reported mining revenue of $6.7 million.
The key growth trigger is the company’s expansion in mining activities in the coming quarters. The company’s mining capacity is likely to triple by Q4 as Riot expects to have 26,900 new miners deployed.
This is likely to translate into strong top-line and cash flow growth. In terms of Bitcoins mined, the results are already evident. In January 2021, the company mined 125 Bitcoins. The number of mined Bitcoins increased to 179 in February 2021.
From a financial perspective, I don’t see any concerns. As of September 2020, the company reported cash and equivalents of $39.1 million. I would not be surprised if the company goes for some equity dilution to fund growth.
Overall, RIOT stock is riding the Bitcoin frenzy and it seems that the cryptocurrency is positioned for wider adoption. This will keep prices firm at higher levels and Bitcoin miners stand to benefit.
RBLX stock is another recent listing that’s trading at lofty valuations. For the current year, Roblox expects revenue of approximately $1.5 billion. At a market capitalization of $38 billion, the stock is trading at 25.3 times forward sales. Furthermore, a forward P/E of 126 seems expensive.
However, even at premium valuations, RBLX stock has been resilient at higher levels. It’s worth noting that Cathie Wood’s ARK Next Generation Internet ETF (NYSEARCA:ARKW) snapped-up 519,000 shares on listing.
It’s also worth noting that for 2021, the company expects revenue growth of 56% to 64% on a YoY basis. However, with international expansion, the company believes that it will have “significant opportunities to grow our business at higher rates again starting in 2022 and beyond.”
Coming back to the financials, Roblox expects operating cash flow (OCF) of $320 million to $340 million for the year. With expectations of accelerated growth from the next year, I would not be surprised if OCF swells beyond $1 billion by FY2023. Therefore, the business has the potential to be a cash flow machine as active users increase in a globally addressable market.
I had been expecting some correction in Pinterest stock. And it did happen, with the shares correcting to $62 from all-time highs of $89.90. The bounce-back has however been strong and the stock currently trades at $75. At a forward P/E of 87, PINS stock would be in the list of overvalued stocks. However, the business is attractive and the stock can continue to command premium valuations.
In terms of business growth triggers, Pinterest reported revenue of $582 million from the U.S. in Q4 2020. This implied a year-on-year growth of 67%. However, international revenue surged by 145% to $123 million.
Furthermore, average revenue per user in the U.S. was $5.94 in Q4 2020. For the same period, ARPU in international markets was 35 cents. With 361 million monthly active users outside the United States, there is a big growth opportunity. Even if the ARPU increases to $1, it will have a big impact on cash flow.
It’s worth noting that the company’s adjusted EBITDA margin has increased from 19% in Q4 2019 to 42% in Q4 2020. Margin expansion is likely to sustain and this is good news for PINS stock. Ultimately, operating cash flows will swell and that’s the key valuation impact factor.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored more than 1,500 stock-specific articles with a focus on the technology, energy and commodities sector.