Closures and safety precautions over the past year definitely created winners and losers in the stock market, and much of that is reversing now that the U.S. is beginning to return to normal. That transition makes it hard for investors to know what to expect from many businesses this year.
With that caveat, it's not difficult to find stocks that are priced for performance they are unlikely to deliver. For instance, it's hard to imagine a scenario where Target (NYSE:TGT), Boston Beer (NYSE:SAM), and CoStar Group (NASDAQ:CSGP) are able to justify the lofty prices being paid for shares right now. They are all pushing the limits of what investors have ever been wiling to pay based on traditional metrics.
The pandemic may have changed how customers view retail big-box stores forever. As the virus spread last year, local governments' forced closures of many small businesses funneled shoppers to destinations like Target, Walmart, and Home Depot. Remaining open helped those megastores capture market share and accelerate their online operations.
Target's full-year results tell the story of a year like no other. The company delivered $92.3 billion in sales in 2020. That was $15.3 billion more than 2019. In fact, the $15 billion increase is more than the past 11 years of growth combined. Digital sales grew 145% year over year.
Those trends will have to persist if Target is going to justify the current price-to-sales (P/S) ratio of 1.14. The stock traded between 0.5 and 0.9 in the years before the pandemic. Even the forward price-to-earnings (P/E) ratio sits near 25. That's a full third higher than its five-year average.
Just because a stock is overvalued doesn't mean it will fall. Target is a great business, and it performed well over the past year. However, based on life returning to normal and how the company typically performs, shareholders might have to wait several years before the business performance catches up to the stock price.
2. Boston Beer
In addition to online shopping, something else people did a lot more of in 2020 was consume alcohol. Boredom, depression, and anxiety all contributed to the uptick. Historically, traumatic events such as Hurricane Katrina and 911 have induced more drinking. The pandemic joined that list in 2020.
The purveyor of Sam Adams, Angry Orchard, and Truly hard seltzer benefited from the increased demand. Depletions -- end sales to retail customers -- rose 37% year over year. Revenue came in at $1.7 billion, up 39%. Truly was a standout, delivering triple-digit volume growth for the year. The trends continued through the first quarter of 2021, with revenue up 65% and depletions rising 48%. That amazing performance probably needs to continue for shareholders to benefit.
Growth over the past decade has been a cycle of boom and bust and boom again. The cyclicality has been driven by new product introductions. That's why its sales growth resembles a movie studio with a series of hits and bombs at the box office. Annual revenue growth has ranged from a 6% decline to the pandemic-soaked 39% in 2020. The average over that decade has been roughly 14%.
During that span, the P/S ratio has been as low as two and as high as eight. It currently sits at seven. For shareholders to be rewarded, not only will the business have to keep performing like it did during a once in a century event, but investors will also have to remain willing to pay nearly the highest premium they ever have.
Like Target, Boston Beer is a wonderful company with excellent leadership. However, the stock has likely already priced in a best case scenario having risen about 200% since the beginning of 2020. Over the very long term, the stock may outperform the market. Achieving that over the next few years will be a tough hurdle to clear from its current price.
3. CoStar Group
One segment of the economy that everyone seemed to agree would suffer during the pandemic was commercial real estate. CoStar, the commercial real estate data provider and operator of online marketplaces Loopnet.com and Apartments.com, is challenging that theory. For 2020, the company's revenue increased 19% to $1.66 billion. Management has offered 2021 guidance for $1.93 billion to $1.945 billion, representing 17% growth. The company held up surprisingly well throughout last year, posting double-digit revenue growth in each quarter.
|Quarter||Revenue||YoY Revenue Growth|
|Q1 2021||$458 million||17%|
|Q4 2020||$444 million||19%|
|Q3 2020||$426 million||21%|
|Q2 2020||$397 million||16%|
|Q1 2020||$392 million||19%|
CoStar is another great business that is probably priced for performance beyond what it can deliver. The company generates a tremendous amount of free cash flow (FCF) -- cash left over after running the operation and investing. In the past few years it has converted about $0.26 of every dollar in sales to FCF. That's similar to Facebook, an awesome cash producer. Like Target and Boston Beer, the problem comes with the valuation.
With a few brief exceptions, CoStar has traded for between 40 and 70 times that FCF over the past eight years. Today, the multiple is 84. Even using management's estimate for 2021 revenue and the historical ratio of FCF to sales puts the metric at 66 looking a year out.
To grow into that valuation, CoStar will need to keep increasing sales. One obvious path was nixed last year when the Federal Trade Commission sued to block its acquisition of the owner of Rent.com and Apartment Guide. Given management's guidance and the current market cap, it won't be until sometime in 2023 that stock reaches the midpoint of its historical price-to-FCF range. That's a long time to wait for what would seem like fair value, even for a wonderful business.