We’ve seen in the last couple of weeks some enhanced market volatility as a result of the new coronavirus variant. But as more information comes out, it doesn’t look like it’s going to be as bad as we all feared. But we did see that this market is incredibly vulnerable to any bad news whatsoever.
Whether it’s inflation-related, virus-related or geopolitical issues with China that are becoming more regular, any little sign of trouble spooks the market, and the high-multiple and loss-making stocks that trade at ridiculous levels but have high institutional ownership are becoming hard to unload.
When things go wrong, the exit door gets really small, and you see massive waves of selling pressure trying to force their way through the door, knocking these stocks down really fast.
So, we have to avoid these stocks that are trading at high multiples because the market is looking very extended. Don’t get caught with these in your portfolio.
Monolithic Power Systems, Inc.
The first one up is Monolithic Power Systems, Inc. (MPWR), which does integrated power semiconductor solutions and power delivery architectures to help power computers in all of the tasks that it has to do. They control the use of electricity and alternate and convert currents as necessary.
They’re basically in about every type of computing system and display monitor in the computing industry, so they’ve had a fantastic run. This is a great company, and the backlighting systems division is seeing a bunch of business.
The stock is very popular and very heavily owned by institutions and hedge funds, with 96% of the shares owned by institutions.
Remember… Hedge funds use a lot of borrowed money and margin. So, if things start to go wrong, there are going to be margin calls and forced selling. That’s even worse than panic selling, and when they come together, it can get ugly really fast.
Again, this is a good company, but it trades at 23 times sales, 122 times earnings and 142 times free cash flow, which is unsustainable. These valuations are crazy, and if anything goes wrong this thing is going to come plummeting back to earth. Don’t let it take your money with it!
Next up is Intuit Inc. (INTU), which is a small business software provider and a fantastic company. It has lots of different growth drivers, and the stock has been very popular.
However, once again, it trades at 85 times earnings, 18 times sales and 72 times free cash flows… Absolutely zero margin for error. 83% of the shares are owned by institutions, so if the selling starts, that could trigger margin calls and another wave of selling.
This stock could be down 40%-50% in the blink of an eye. It is a great company, and if we see massive selling in this stock then you might think about being a buyer, but I don’t think you want to be an owner at these levels.
Insiders seem to feel the same way, as we’re seeing a lot of sales, including a $24 million sale of stock by the CEO in the open market recently. If insiders are bailing out of a stock that has high levels of institutional ownership and nosebleed valuations, maybe we should do the same and avoid being caught with this thing in our portfolio when things do go bad.
Palo Alto Networks, Inc.
Next up is one that hurts my heart a little bit… I happen to be a ridiculous bull on cybersecurity. Everything technology-related, including your kitchen appliances, has its own security software program.
Everything is going to need to be protected. It’s going to touch every industry, every technology, all the high-growth areas, connected cars, artificial intelligence… It doesn’t matter what it is. Cybersecurity is going to be a big part of the story.
However, Palo Alto Networks, Inc. (PANW), one of the best cybersecurity companies on the market, is next on the list. The stock has been on fire and made people a lot of money, but I really think that it’s just about over.
Don’t get me wrong. This will be a massive story going forward, probably forever. But remember what the massive story was in 1999? Networking. Networking and the internet was the massive story, and Cisco was going to grow by leaps and bounds…
Well, it was a massive story, and Cisco has grown by leaps and bounds. But investors in Cisco still haven’t made their money back if they bought the highs. Software was also a massive story back in 1999, and most of the software companies from back then are just gone.
But let’s use a fair example and use Microsoft. If you bought Microsoft at that high price in 1999, you broke even in 2017. It took that long.
Not too many people would have had the patience to sit there and own stock long enough to recover their initial investment. Now, because of the spike that we’ve seen in tech stocks, Microsoft since 2017 has shot up six-fold.
Those investors going all the way back to 1999 would have a compound rate of return of just 8.5%, which is not going to be enough of a return to pay for the amount of antacid they would have had to take along that very difficult and bumpy road to make back their money in this software leader.
Now, Palo Alto is clearly one of the leaders in the cybersecurity space. It’s a great company, and if we saw a massive bear market like we saw in 2008-2009, this would be one of the first stocks that I would be buying in the open market. I really like the company, but I hate the valuation.
Even with aggressive future growth and great business conditions, my valuation calculations could only get the stock up to $171 a share. But the current price is over $500 a share right.
It trades at 11.5 times sales, and they’re not going to be profitable this year. They’re trading at about 60 times what analysts are hoping they’ll make next year and about 37 times free cash flow, which is not justifiable.
The company is going to grow at a nice pace but not high enough to justify these numbers. If we see a bad market or something happens to drive this stock down, I’ll be a buyer. But at this price, I do not want to be an owner of the stock.
If anything goes wrong, and something always does, this stock is going to go into a power dive and decrease your net worth substantially.
Great company. Great business. Horrible valuation. That’s an easy way to lose money because the good aspects can lull you into a false sense of security, and you end up owning the stock right when everything goes wrong.
Subscribe today and receive daily advice right in your inbox, guiding you to a better way to wealth.