Should You Be Scared to Hold These 3 Companies Ahead of Earnings?http://www.fool.com/investing/general/2013/10/23/should-you-be-scared-to-hold-these-3-companies-ahe.aspx Brian Nichols
October 23, 2013
Netflix (NASDAQ: NFLX) has been one of the greatest momentum stocks of the last year, and after reporting earnings, it initially traded considerably higher. However, we then saw a change in perception, and profit taking. This fact might prove worrisome for shareholders of other momentum stocks, and especially three stocks in particular.
A sign of things to come?
The most striking metric might be the 1.29 million subscribers added, versus the 630,000 that were added in the company's previous quarter. Therefore, total subscribers now stand at 31.09 million, and many believe that Netflix will aim to create more original shows thanks to its early success.
Initially, the reaction to this quarter was euphoric, as the stock gained nearly 10% on top of its 5% gains from the day prior. The stock was very close to $400 in premarket hours, but then once the market opened, shares nose-dived to $320.
Notably, nothing fundamental had changed. The company's revenue growth was 5% and its margins improved. However, this quick reaction and the sudden move lower should make many very wary as other momentum stocks face earnings.
With that said, we are facing a situation where many of the market's best performing stocks trade at insane multiples to fundamentals, have high expectations with large YTD gains, and trade with extremely high betas (a stock's volatility compared to the market). In particular, there are three that come to mind:
Don't expect a repeat of recent history!
Moreover, mobile finally became relevant for Facebook, accounting for more than 40% of total revenue. In addition, Facebook guided for lower costs and new exciting services. Now, fast-forward three months later and Facebook's stock has more than doubled, and it is a $130 billion company!
Thus, the pure size of this company makes it a risk, and the fact that it trades at 21.5 times sales. When a company is valued at less than $20 billion, massive premiums can be sustained, as there is always new money on the table. But for a $130 billion company, we are reaching a point where fundamentals and valuation must at some point align. Hence, I'd be careful ahead of earnings on October 30, because there is likely more downside than upside. Nonetheless, I wouldn't expect another double in the next three months.
At some point the bubble must burst?
Staying on the same subject, LinkedIn (NYSE: LNKD) is another social media stock with an insane premium compared to fundamentals. However, unlike Facebook, LinkedIn's valuation has been consistent, and not all of a sudden.
In the last year, LinkedIn has gained 130%, and now trades at 22.5 times sales. In the company's last quarter, revenue growth was 59%, which adds to a continued trend of lower year-over-year growth that we've seen in recent quarters.
Below, you can see a chart which shows the company's year-over-year growth over the last six quarters. Quickly, you'll see a trend.
Like I said, each quarter the company's year-over-year growth has decelerated. Yet, its premium to both net income and revenue continues to rise. Sooner or later, this trend will end, and for current investors, you have to at least wonder if October 29 might be that ending quarter.
Will reason finally defeat irrational exuberance?
Workday is a HR/payroll company that offers its services through the cloud, one with trailing 12 months sales of just $353 million , but a market cap of $13.87 billion! In other words, Workday trades at a whopping 40 times sales!
Moreover, Workday is not profitable; it has operating margins of negative 35.4%. Also, with the exception of its most recent quarter – historically a strong quarter for cloud-based company – revenue has consistently declined year-over-year.