For many, Halloween is a time of celebration. It allows children to let their imaginations run wild, while giving adults a chance to relive their youth, at least for one day.
But for investors, it offers the perfect opportunity to exercise the proverbial demons from their portfolios. With a multitude of economic indicators forecasting weakness to come for the U.S. economy and stock market, owning stocks at premium valuations may not be advisable.
What follows are three stock valuations that are, arguably, scarier than any ghoul or ghost in the current economic climate.
Image source: Getty Images.
Nvidia
The first truly ghoulish stock that could have a very difficult time living up to investors' lofty expectations (and its current frothy valuation) is semiconductor company Nvidia (NVDA 6.18%).
Nvidia has had nothing short of a stellar year -- shares are up 177%, as of Oct. 29 -- thanks to the artificial intelligence (AI) revolution. The company's AI-driven A100 and H100 graphics processing units (GPUs) absolutely dominate high-compute data centers. Due to exceptional pricing power for its GPUs, Nvidia's sales are expected to more than double in fiscal 2024.
But there are a number of reasons to believe Nvidia's AI-fueled rally could falter sooner than later. For one, every next-big-thing trend over the past 30 years has undergone an initial period of euphoria that was followed by a bubble-popping event. It'll probably take years for AI to mature as a technology, which means demand for Nvidia's GPUs could struggle to meet already-lofty forecasts.
To build on the above, Nvidia may, ironically, struggle as its production of A100 and H100 GPUs expands next year. Supply chain constraints at chip-fab giant Taiwan Semiconductor Manufacturing have limited sales of Nvidia's AI GPUs. But with some of these constraints expected to ease in the coming year, Nvidia's GPUs will be less scarce. As product sales ramp up and access to AI-accelerated GPUs becomes easier, Nvidia could see its pricing power, and gross margin, meaningfully decline.
Nvidia also isn't going to be the only game in town for much longer in AI-accelerated data centers. Advanced Micro Devices introduced its MI300X GPU to rival Nvidia in June. Though it's only being delivered to a handful of companies this year, AMD's MI300X will be set for widespread distribution in 2024. Likewise, Intel plans to bring its Falcon Shores GPU to market in 2025. In other words, Nvidia's market share in high-compute data centers has seemingly nowhere to go but down.
After trading at a reasonable 11 to 17 times year-end cash flow between 2013 and 2015, Nvidia is commanding a multiple of 41 times forecast cash flow in fiscal 2024. Nvidia stock will likely struggle to sustain this premium, especially if U.S. economic growth weakens in the coming quarters.
MicroStrategy
A second stock with a truly frightening valuation, as of this Halloween, is enterprise software analytics provider MicroStrategy (MSTR 3.38%).
Although MicroStrategy is a software provider in name, it's largely being treated as a leveraged bet on the price of Bitcoin (BTC 1.32%), the world's largest cryptocurrency by market cap. MicroStrategy's CEO, Michael Saylor, believes Bitcoin represents the future of banking and provides an affordable and secure way for people to transact and grow their wealth. Saylor's company is holding a jaw-dropping 152,800 Bitcoins (worth $5.24 billion, as of Oct. 30) on its balance sheet, as of July 31.
As you can guess by the inclusion of MicroStrategy on this list, I'm not a fan of its all-in-on-Bitcoin strategy for a variety of reasons.
To start with, the company has issued more than $2 billion in long-term debt, as well as sold well over $1 billion in common stock, to raise capital to purchase additional Bitcoin. It would be one thing if the company's operations were generating meaningful profits and operating cash flow was being used to purchase additional Bitcoin. What Saylor is doing is utilizing capital that the company doesn't have to purchase a digital asset that produces nothing. That's extremely risky.
Secondly, I'm an admitted Bitcoin skeptic. While Bitcoin is revered for its scarcity and first-mover advantages, it leaves a lot to be desired. Its scarcity is purely a function of computer code and has nothing to do with any true, physical rarity. Further, Bitcoin transaction costs are still considerably higher than other payment-focused cryptocurrency projects, and its network processes transactions notably slower than a number of other payment tokens. In short, Bitcoin had first-mover advantages, but it's been mostly left in the dust by third-generation blockchains.
The final issue with MicroStrategy is that its actual business, enterprise software analytics, has been going nowhere for years. Saylor has been so distracted by his overleveraged bet on Bitcoin that annual sales have declined by 13% over the past decade.
A company with effectively no growth and what I'd deem a renegade CEO shouldn't be valued at more than 11 times sales, especially with operating losses forecast by Wall Street in 2024.
A Tesla Model S charging. Image source: Tesla.
Tesla
The third stock valuation that's, arguably, scarier than any ghoul or ghost you'll encounter this Halloween is none other than electric vehicle (EV) maker Tesla (TSLA -1.11%).
Last week, I gave credit where credit is due by pointing out that Tesla is the first automaker in more than a half-century to have successfully built itself from the ground up to mass production. It's relied on its first-mover advantages and become the only EV pure-play to generate a recurring profit. Based on its recently released third-quarter operating results, it looks to be well on its way to a fourth consecutive year of generally accepted accounting principles (GAAP) profit.
But the world's largest automaker by market cap also comes with a considerable amount of risk for investors.
Earlier this year, Tesla kicked off a price war with other EV manufacturers. With CEO Elon Musk having previously told investors that his company's pricing strategy is based on demand, the company's more than half-dozen price cuts across its four production models (3, S, X, and Y) signals that inventory levels are rising and/or competition is heating up. Regardless of the primary cause, it's resulted in Tesla's operating margin falling by more than 50% over the past year.
Another concern is how Tesla is generating its profit. Fast-paced, industry-leading companies should allow their operating performance to do the talking. However, 41% of the company's pre-tax profit in the September-ended quarter derived from the sale of automotive regulatory credits to other automakers and interest income earned on cash. In other words, these are profits that have absolutely nothing to do with selling and leasing EVs.
Elon Musk himself is a risk that shouldn't be ignored, either. He's found himself in the crosshairs of securities regulators on more than one occasion. Worse yet, he's made a bad habit of overpromising and underdelivering when it comes to new innovations. Most of Musk's promises have been baked into his company's valuation, yet few of these expectations have been realized.
If Tesla's operating margin were many multiples higher than the auto industry average, it might merit a considerable premium. But with its operating margin on par with other auto stocks, a price-to-earnings ratio of nearly 70, based on Wall Street's consensus earning for 2023, makes little sense, given the current uncertain economic climate.
