When a stock rallies to the point that it trades at a premium to its industry peers, analysts often declare that it's "priced for perfection." This means that a negative headline, earnings miss, or soft guidance could cause the stock to quickly give up its gains.
Companies like this often need to beat, not just meet, expectations every quarter to continue rising. Let's examine three stocks that fall into that category, and whether or not they can keep impressing investors.
Chipmaker NVIDIA (NVDA 4.28%) rallied more than 200% over the past 12 months, thanks to robust sales of its GPUs in the gaming and data center markets as well as strong sales of its CPUs for connected cars.
Analysts expect NVIDIA's revenue and earnings to both rise 20% this year. However, NVIDIA now trades at 48 times earnings, which is double the industry average of 24 for semiconductor makers and higher than its estimated earnings growth rate.
Looking ahead, NVIDIA will face numerous challenges. AMD will soon launch its next-gen Vega GPUs, which could give it an edge against NVIDIA's current-gen Pascal cards. Intel plans to strike back at NVIDIA's data center GPUs with Knights Bridge, a new CPU aimed at processing machine learning tasks more efficiently than NVIDIA's GPUs.
Once Qualcomm closes its acquisition of NXP Semiconductors, it will become the largest automotive chipmaker in the world and become a threat to NVIDIA's automotive unit. All these factors could cause headaches for NVIDIA -- so investors should exercise caution with this pricey stock.
Chinese social network Weibo (WB -0.56%), often called the "Chinese Twitter", surged 140% over the past 12 months. Its double-digit user growth, double-digit sales growth, and triple-digit earnings growth impressed investors.
Analysts see Weibo's revenue and earnings respectively rising 60% and 84% this year. However, the stock trades at a whopping 104 times earnings, which is triple the industry average of 35 for internet information providers.
Weibo faces two daunting challenges. First, Chinese regulators recently ordered it to stop streaming video and audio content until it obtained a government-issued license. That blow could throttle its growth, since video-related revenue accounted for 18% of its top line last quarter. Second, Tencent is expanding WeChat, the most popular messaging app in China, as a social ecosystem -- one that overlaps many of Weibo's key features.
I previously owned Weibo, but I think the stock has become too hot to handle. Instead, I'd recommend investing in Weibo's parent company, SINA (SINA), as a safer play. SINA has less impressive growth figures, but it generates most of its revenue from Weibo and trades at just 26 times earnings.
Amazon (AMZN 2.07%), the world's biggest e-commerce marketplace and cloud infrastructure platform provider, rallied more than 30% over the past 12 months. That rally was fueled by AWS (Amazon Web Services), which has higher margins than the company's marketplace business, providing the company with consistent bottom line growth. That growth enabled Amazon to expand its marketplace ecosystem with new prisoner-taking features for Amazon Prime.
That's why Wall Street expects Amazon's revenue and earnings to respectively rise 22% and 36% this year. However, the bears argue that Amazon's P/E of 183 -- which is much higher than the industry average of 43 for specialty retailers -- is far too high.
They'll also note that Amazon's planned acquisition of Whole Foods could throttle its bottom line growth, and that resurgent rivals in the cloud -- like Oracle -- may counter AWS with new features.
Those challenges are worth watching, but I personally believe that the scale of Amazon's marketplace and cloud businesses make it a very tough nut to crack. Amazon has never traded at "reasonable" valuations before, and I think investors will keep buying this stock on any major dips -- so long as it doesn't face any viable competitors.
The key takeaways
As the market hovers near historic highs with frothy valuations, investors should beware of stocks trading at steep premiums to their industry peers. NVIDIA, Weibo, and Amazon are all moving in the right direction, but they need to repeatedly impress investors -- which will become increasingly difficult as expectations keep rising.