Many of the hottest stocks on the markets right now are those of companies developing potential vaccines or treatments for COVID-19, or businesses that are well-suited to the transformed economic conditions of the coronavirus pandemic. Moderna (MRNA -0.47%) is one example, with its stock up by 256% year to date. It's one of the few vaccine developers that has advanced its coronavirus vaccine candidate into phase 3 clinical trials.
But investors need to be aware that in the long run, certain high flying stocks may not be able to maintain their attractive positions and current competitive advantages. Indeed, there's a real risk that Moderna and other stocks that COVID-19 has boosted this year could ultimately crash. Here are a few reasons why investors need to be careful when buying shares of companies that are doing especially well amid the pandemic.
1. Higher demand may not be sustainable once the pandemic subsides
COVID-19 infections aren't likely to continue rising at today's rapid rate with the U.S. reaching 5 million cases over roughly five months. And once these difficult conditions fade and there's more normalcy in everyone's lives, it will change the outlook for stocks that are thriving in the coronavirus pandemic. Certain companies may no longer be able to deliver significant growth.
Image source: Getty Images.
In Moderna's case, demand for a vaccine, which is overwhelming in 2020, could eventually wane. It's possible that the coronavirus will re-emerge seasonally, and people could need annual vaccinations, in which case Moderna could benefit from recurring demand for its vaccine. Either way, Moderna's vaccine candidate is still far from a sure thing, adding another layer of risk for any investors thinking about buying shares today. The bottom line is that investors should be prepared in the event that the demand for any particular vaccine doesn't become permanent, whether it's due to the slowing of coronavirus cases or competition from other vaccines. There need to be other prospects in the underlying business for investors to fall back on beyond a vaccine.
The Massachusetts-based company released its second-quarter results on Aug. 5 where it reported sales of $66.4 million -- 407% higher than the prior-year period. Moderna credits the increase to the development of its vaccine candidate and an increase in collaboration revenue, boosted by a strong quarter from AstraZeneca.
The company's grant revenue of $37.9 million -- $37 million of which is from the Biomedical Advanced Research and Development Authority (BARDA) -- makes up the bulk (57%) of Moderna's top line. That's a significant piece of the company's revenue that's dependent on one-time funding.
Another company that's doing well during the pandemic is Clorox, (CLX -1.03%) with its stock up 46% year to date. The California-based consumer goods business is known for its cleaning products, which are in high demand as people and companies stay vigilant about sanitizing to minimize the spread of COVID-19.
Clorox released its fourth-quarter results on Aug. 3 and sales of $1.98 billion for the period were up an impressive 22%. For the full fiscal year, revenue of $6.7 billion rose by 8.2%. But the year before that, sales were up by just 1.5% and that was down from the 2.5% sales growth Clorox reported in the previous year.
It's likely that as the pandemic subsides and becomes less of a constant threat, Clorox will return to single-digit growth. While there's strong demand for sanitization now and it may remain a priority for many years to come, it's an added cost for businesses that many will be eager to shed in hopes of strengthening their bottom lines, which COVID-19 has dented.
Valuations are high
Even if you think companies like Moderna and Clorox are still good investments, the problem is that buying them at their current prices may be unappealing due to their inflated valuations. Considering their respective sales numbers, investors are paying much more today for these stocks than they were before the pandemic:
MRNA PS Ratio data by YCharts
Generally, investors pay a premium for a stock because they expect the business will do even better in the future, baking those expectations into the current price of the stock. But in a few years, or however long it takes for concerns surrounding the pandemic to dim, the outlook may be less rosy. And that could leave stocks like Clorox and Moderna vulnerable to corrections and their share prices may even crash if their sales fail to support their heightened valuations.
What should investors do?
This doesn't mean investors shouldn't invest in these stocks, but that extra attention is needed on their valuations and the strength of their underlying businesses. Shares of both Moderna and Clorox have been rising rapidly this year and soundly outperforming the S&P 500:
Investors need to assess whether these and other companies are strong investments beyond COVID-19, and how they look in a scenario where life moves toward normalcy. While new COVID-19 cases may continue to pop up for many years, investors shouldn't assume the pandemic is a long-term situation and ought to avoid investing based on that assumption. Making investment decisions based on that kind of uncertainty can lead to problems. It could leave you holding a stock that's overpriced and where the company's outlook for the future may not be nearly as optimistic as it once was.
That's why it's important to look at longer-term horizons and not ignore valuations when deciding whether a stock is a good buy. While investors are bullish on Moderna and Clorox right now, these are two stocks that could crash hard if demand for their products falls as the rate of COVID-19 slows, which is why I'd stay away from both of them today.
