Investors have learned two valuable lessons in one of the wildest years on record.
First of all, they've been taught the importance of long-term investing. Despite the benchmark S&P 500 losing more than a third of its value in less than five weeks, it took under five months for the widely followed index to recoup all of its losses. Though this rebound was historically fast, the fact remains that each and every stock market correction in history is eventually put into the rearview mirror by a bull market rally.
Secondly, investors have been reminded that winners keep winning. Even though the S&P 500 is relatively unchanged for the year, through Sept. 24, many of the stocks that have moved higher on a year-to-date basis are proven winners.
However, a handful of these wildly successful stocks are companies that I wouldn't buy, even if given free money. Although I've been dead wrong about all three of these highly popular stocks in the past, I can't, in any way, justify putting money to work at their current valuations.
Let's face it, Tesla (TSLA 4.16%) might be the most polarizing stock on Wall Street. You either love it or hate it -- and I happen to fall into the latter camp.
To get some housecleaning out of the way, Tesla and its CEO Elon Musk absolutely do deserve some kudos. It's ridden its first-mover advantage in mass-produced electric vehicles (EV) to a valuation that easily topped $400 billion recently. Many before Musk have tried and face-planted when attempting to build a brand-new automotive company from the ground up.
With at least 500,000 vehicles expected to be delivered in 2020 and the company announcing ambitious plan to build revamped batteries in-house, Tesla might look like a no-brainer buy. But I'm not buying into this growth story for a variety of reasons.
For one, Tesla's innovative genius comes with a cost, too. Specifically, its CEO can be as much of a liability as a help. Elon Musk frequently sets production goals and aggressive new-products debut dates only to have those projects continually pushed back by unforeseen challenges. To be clear, I'm not saying Musk fails to deliver on the products he promises. Rather, his ideas are often far too ambitious for the time frames provided. If you think you're getting a $25,000 EV anytime soon, I'd suggest you temper those expectations.
Secondly, even though Tesla's valuation has really never been about anything having to do with current fundamentals, we're now more than eight years past the rollout of the first Model S sedan. If we ignore the Roadster and count the Model S as Tesla's first real success, it's been long enough for Tesla to prove to Wall Street that it has what it takes to generate a profit. But all we've seen are EV credits driving adjusted results higher while Tesla continues to generate generally accepted accounting principle (GAAP) losses on a full-year basis.
I'm also not convinced that Tesla's technology superiority is sustainable. General Motors, Ford, and a host of other automakers have much deeper pockets than Tesla, and the number of EV competitors is growing by the year. Tesla's once-dominant lead in mileage range per charge is no longer as big. Over time, I expect competitors to close this gap, which is what makes paying $361 billion for Tesla nothing short of ludicrous.
Chipotle Mexican Grill
Another exceptionally popular stock that's been lights-out since its initial public offering 14 years ago is fast-casual restaurant chain Chipotle Mexican Grill (CMG 0.51%). Shares are up nearly 2,700% since their debut in 2006.
Chipotle has done a lot of things right. It's using only high-quality, natural ingredients in its food, which consumers have been more than willing to pay extra for. It also was one of the first restaurant chains to master the fast-casual dining model, which balances the time demands of customers with the want for high-quality food. And most recently, the company has delivered during the coronavirus crisis by focusing on digital sales, its delivery partnerships, and even adding "Chipotlanes" (a modernized drive-thru mobile order service) to some of its newer locations.
But there's a pretty big issue if you're an investor on the outside looking in: the valuation.
If you were to buy a share of Chipotle Mexican Grill on Sept. 24, you'd pay 136 times trailing 12-month earnings and 59 times forward earnings. Even factoring in the upheaval caused by the coronavirus pandemic, the S&P 500 restaurant industry (which includes Chipotle) has a forward P/E in 2021 of a little over 31. According to Wall Street's profit expectations, Chipotle won't have a price-to-earnings ratio below 30 until 2024 -- and that assumes its share price remains static, which is unlikely.
What's more, I struggle to believe that Chipotle is that far ahead of its competition on a sustainable basis. For instance, the company is getting heaped with praise for modernizing drive-thru lanes and digitizing the ordering process during the pandemic. But Chipotle didn't reinvent the wheel. Many of its peers were already catering to new ordering systems and focusing on customer convenience well before the coronavirus.
It ultimately boils down to this for me: It's just food. Even the best fast-casual chains aren't going to grow sales by more than roughly 10% to 12% a year, with a good portion of this sales growth derived from new store openings. Paying over 34 times next years' forecast operating cash flow for a food company makes no sense.
Last, but not least, we have streaming giant Netflix (NFLX 4.72%). As a Netflix bear I have been very, very wrong, with shares of the company up close to 8,600% since the bottom of the Great Recession in March 2009.
Some of you might recall that Netflix CEO Reed Hastings took a lot of heat in 2011 when he announced plans to split up the company's video streaming and DVD rental segments into two separate businesses. Though Hastings and his team eventually decided against this split, it ultimately was the key turning point that put Netflix on the path of streaming domination. Today, it's a company with almost 193 million global streaming paid memberships, 72 million of which are located in the United States or Canada.
As part of the illustrious FAANG stocks, Netflix has been veritably unstoppable. But as an outsider with cash, it's not a stock I would ever consider putting money into.
My biggest issue with Netflix happens to be its valuation. But not the traditional fundamental metrics that are typically used to assess value. Since the FAANG stocks commonly reinvest cash flow from their operations back into their businesses, I'm a big fan of using cash flow as a measure of investment attractiveness. Whereas the other four FAANG stocks are generating big-time free cash flow, Netflix continues to produce a net cash outflow every year as it spends aggressively in foreign markets. At some point, the goalposts need to stop moving and Netflix needs to demonstrate to Wall Street that it's not a cash-burning machine, because that's how I continue to view the company.
I'd also point out that there are some deep-pocketed players in the streaming space. Netflix may have a streaming focus and first-mover advantage, but it doesn't have the pockets to match the likes of Amazon, Walt Disney, or any of the other major networks, should they choose to throw their weight around. For the time being, Netflix's original series have been a boon for the company. But original production success could prove as fleeting as its once-dominant lead in the U.S. streaming market.
There's simply no reason anyone should be paying an estimated 331 times 2022's projected operating cash flow for a company with slowly declining streaming market share in the U.S.