Investors can be an optimistic bunch, pushing a stock's valuation to a level that assumes the best-case scenario is all but assured. This can work out fine if everything goes right, but any speed bump can lead to disaster.
Snap Inc. (NYSE:SNAP), Wayfair (NYSE:W), and Advanced Micro Devices (NASDAQ:AMD) all trade at lofty, optimistic valuations. Investors are betting that all three companies will grow swiftly, eventually justifying those valuations with future profits. Possible? Sure. Likely? Read on to find out.
A ludicrous valuation
After partially recovering from a thumping following a disastrous first-quarter report, Snap Inc. is worth nearly $24 billion. What do you get for that price?
- Trailing-12-month revenue of $515 million.
- A free cash flow loss of $173 million in the first quarter alone.
- Quarter-to-quarter daily active user growth of just 5% in the first quarter.
- Absolutely no voting rights whatsoever.
- An app with features that are being copied wholesale by Facebook.
Snap is priced like it's the next Facebook, but it looks far more likely to be the next Twitter. Twitter once sported a bonkers valuation, as well, with its market capitalization topping out well above $30 billion. Slowing user growth and massive, persistent losses eventually put an end to that optimism: Twitter stock is down 75% from its all-time high.
Snap needs to re-accelerate growth and start moving toward profitability. I have no confidence that it can do either of those things, let alone both simultaneously. The Snapchat app has a narrow appeal, and it lacks the inherent usefulness of Facebook and Twitter. It would take a miracle for Snap to ever live up to its outrageous valuation.
Burning cash like there's no tomorrow
Shares of online furniture retailer Wayfair recently exploded higher after the company beat analyst estimates during the first quarter, carving out a new all-time high. The number of active customers surged 46% year over year, driving a 29% increase in revenue. Repeat customers accounted for about 60% of all orders.
Another thing that grew quickly: Wayfair's losses. The company posted an operating loss of $56.2 million, worse than a loss of $40.9 million during the prior-year period. Advertising expenses ate up 12.3% of revenue and 50% of gross profit, despite all those repeat customers. Free cash flow was a loss of $69 million.
Wayfair's plan is to eventually bring down advertising costs as a percentage of revenue, something that will require the company to gain more scale. The long-term goal is to spend just 6%-8% of revenue on advertising. That will be tough given the competitiveness of online retail. Wayfair has Amazon.com -- which is currently making a big push into furniture -- to worry about, as well as traditional retailers that are aiming to grow their e-commerce businesses.
A lot of things need to go right for Wayfair to reach profitability and justify its current valuation. A bet on Wayfair is, in a sense, a bet against Amazon's furniture ambitions. Good luck with that.
No room for error
Shares of Advanced Micro Devices (NASDAQ:AMD) quadrupled in 2016, driven higher by optimism surrounding the company's product launches. AMD has already launched some of its Ryzen PC CPUs, and its EPYC server CPUs and Vega high-end GPUs are coming soon.
There's a bit of a problem, though. AMD is aiming to earn at least $0.75 in per-share adjusted earnings by 2020, and the stock already trades for nearly 15 times that number. The valuation was even higher a few months ago -- AMD stock has declined by about 28% from its 2017 peak, driven by lackluster guidance and a rumor about a possible licensing deal with Intel being debunked. Even after the decline, the market is pricing in something close to the best-case scenario.
AMD is starting from way behind in every market it's targeting, so the company will pick up at least some market share. But Intel and NVIDIA are going to react, with new products, price cuts, or both. Neither will willingly cede share to AMD, especially in the lucrative high-end CPU and GPU markets.
AMD stock is priced like the company is going to return to its former glory. Anything short of that will be a disaster for the stock.
Timothy Green has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon, Facebook, Nvidia, Twitter, and Wayfair. The Motley Fool recommends Intel. The Motley Fool has a disclosure policy.