As the market hovers near all-time highs, investors should be wary of chasing stocks with frothy valuations. Today, we'll take a look at three stocks that appear overvalued -- Under Armour (UA -1.97%) (UAA -2.34%), Unity Software (U -1.06%), and JFrog (FROG 1.61%) -- and why they could burn investors if the market crashes.
1. Under Armour
Under Armour's stock has tumbled about 60% over the past five years as the footwear and athletic apparel maker's growth decelerated, it missed its own revenue targets, and it struggled to keep pace with its larger rivals Nike (NKE -0.74%) and Adidas.
Image source: Under Armour.
UA founder Kevin Plank's polarizing support for President Trump, tepid consumer interest in the company's flagship Curry shoes, and an SEC probe into allegations of inflated revenue exacerbated the pain. All those problems prevented Under Armour from recovering from the pandemic as rapidly as Nike and other footwear makers.
Under Armour's revenue rose just 1% in 2019, and it generated a slim profit, compared to a loss in 2018. Its revenue tumbled 20% year over year in the first nine months of 2020, mainly due to store closures, and it dipped into the red again. The company expects its revenue to decline at a high-teen percentage rate for the full year.
Those numbers look terrible, but both classes of UA's stock still inexplicably trade at over 100 times forward earnings -- assuming the company can squeeze out a tiny profit next year. That makes UA a much pricier stock than Nike, which is generating positive revenue and earnings growth again and trades at 50 times forward earnings.
2. Unity Software
Unity Software, which develops a software engine for video games and other applications, was one of the hottest tech IPOs of 2020. It went public at $52 per share last September, and nearly tripled to about $150, giving it a market cap of $40.3 billion.
The Unity Engine makes it easier to develop cross-platform games by bundling together rendering, lighting, physics, sound, animation, and user interface tools. Developers previously created those features separately for different platforms, which was a buggier and more tedious process.
Image source: Getty Images.
Over half of all PC, mobile, and console games are now built with the Unity Engine. The company's revenue rose 42% last year, and grew another 44% year over year to $552 million in the first nine months of 2020. It expects its revenue to rise 39%-40% for the full year.
But next year, analysts expect its revenue to rise just 26% as the pandemic-induced surge in gaming wanes. Unity also remains unprofitable -- its net loss widened from $132 million to $163 million in 2019, then widened again year over year from $113 million to $199 million in the first nine months of 2020.
Unity is still growing, but the stock is simply too expensive at over 40 times next year's sales. Its stock is priced for perfection, and it doesn't seem to fully reflect its decelerating post-pandemic growth, widening losses, or competition from rival platforms like Epic Games' Unreal Engine.
3. JFrog
JFrog was another hot software IPO last year. It went public at $44 a share last September and currently trades at about $60, which gives it a market cap of about $5.6 billion.
JFrog's core platform, Artifactory, stores software updates on a universal repository that can be accessed by multiple computing platforms. This silo-busting service eliminates the need for tedious manual updates across multiple systems and ensures a company's software remains up to date.
There's plenty of pent-up demand for JFrog's services. Its revenue rose 65% to $104.7 million last year and climbed another 46% year over year to $108.1 million in the first nine months of 2020. The company expects its revenue to rise 42%-43% for the full year, and analysts expect 31% growth next year.
But JFrog still isn't profitable. Its net loss narrowed from $26 million in 2018 to $5.4 million in 2019 but widened year over year from $5.2 million to $5.7 million in the first nine months of 2020. It also faces potential competition from similar integrated services in big cloud platforms, including Amazon Web Services' (AWS) CodeArtifact and Microsoft's Azure DevOps with GitHub.
Those challenges make it tough to justify paying nearly 30 times next year's sales for JFrog. The company has a disruptive business model, but investors shouldn't pay the wrong price for the right company.
