"We always hurt the ones we love," goes the old saw. And this morning, analysts at Californian institutional broker BTIG LLC gave a good whack to one of their favorite stocks -- Australian software maker Atlassian Corporation (NASDAQ:TEAM).
Atlassian, for those not familiar, is a pretty big deal in Australia, a $6.5 billion company that makes software for team planning and project management. Atlassian stock has also performed pretty well, with a stock price that BTIG boasts grew "+60% in the past six months" alone.
On the one hand, that's good news for BTIG, which up until today had recommended the stock as a buy. On the other hand, it's bad news for shareholders today -- because BTIG has just downgraded the stock to neutral, and Atlassian stock is responding with a 7% sell-off.
Here's what you need to know.
1. The ones we love
BTIG's announcement that it's recommending selling Atlassian stock came as a bit of a shock to the market, as well it should. As the analyst itself admits, there's very little going wrong with Atlassian's business today. As related in a story on StreetInsider.com this morning, BTIG still believes "the company can drive strong revenue growth (>40% y/y for the third straight year) while still maintaining an impressive margin profile (~17% for FY16, +150bps y/y)."
In short, Atlassian stock isn't up 60% in six months for no reason. The stock is up because the company behind the stock is doing great.
2. The future looks bright
What's more, BTIG expects Atlassian to continue doing great. Citing management guidance for 30% revenue growth in fiscal 2017, BTIG says that number "looks conservative." In its short life as a public company (Atlassian went public only last year), Atlassian has already managed to train Wall Street to expect "beat and raise" -type earnings reports, where the company both beats analyst estimates with a stick, and then raises its guidance for the coming quarter.
That's the kind of news Wall Street likes to see, and it's helped to propel Atlassian's stock price upwards.
3. Too fast, too high
And yet, like Icarus, BTIG fears that Atlassian's stock is now flying too high. In an assessment just bursting with understatement, the analyst points out that Atlassian stock today sells for more than 10 times this year's expected revenue -- not profits, mind you, but revenue.
Given this fact, BTIG no longer considers the shares cheap enough to buy, and suggests investors are better off awaiting "a pull-back in shares" before buying into this growth story.
The most important thing: Valuation
So is selling Atlassian stock the right move to make? Is now the right time to make it? It's hard to say.
Here's why: Say you agree that a stock selling for 10 times the value of its annual sales is expensive, and likely to decline in price. Wouldn't you also say the same thing about a stock that sold for eight times sales? Nine times sales? 9.5 times sales?
Yet Atlassian has passed all those valuations over the past several months, and the fact that the stock looked overpriced then didn't prevent the stock from continuing to rise to hit the price it fetches today. Simply put, once a stock has got momentum, it's hard to predict when it will stop rising, no matter how expensive it gets, or how obvious its overvaluation becomes. So long as it keeps beating and raising, investors keep buying...until they don't.
That said, I certainly agree with BTIG that Atlassian's stock has gotten a bit big for its britches. Valued on trailing numbers, the stock actually sells for more than 14 times sales today, for 69 times free cash flow (according to data from S&P Global Market Intelligence), and for -- better sit down for this -- 1,487 times earnings.
Those are all some pretty high-in-the-sky numbers. Meanwhile, most analysts who follow the stock only expect to see the stock grow earnings at about 25% annually over the next five years. Even if they're wrong, and even if BTIG is right about the growth rate probably being closer to 30% or even ">40%," it's hard to see how the stock can ever earn enough profit to justify the prices investors are paying for it, any time in the foreseeable future.
BTIG is right to be cautious today. If you own Atlassian stock, you should be cautious, too.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he currently ranks No. 308 out of more than 75,000 rated members.
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