Zacks Investment Ideas feature highlights: Amazon, Medidata Solutions, Qualys
CHICAGO, Feb. 25, 2014
CHICAGO, Feb. 25, 2014 /PRNewswire/ -- Today, Zacks Investment Ideas feature
highlights Features: Amazon (Nasdaq:AMZN-Free Report), Medidata Solutions
(Nasdaq:MDSO-Free Report), Qualys (Nasdaq:QLYS-Free Report) and LinkedIn
4 Expensive Stocks to Avoid
"There are always people who say that the rules have changed. But it only
looks that way, if the time horizon is too short." - Warren Buffett
Equity investors are certainly feeling more confident these days. While it's
difficult to say whether or not the market as a whole is overvalued at this
stage, there is certainly a bit of "irrational exuberance" among investors in
some individual stocks.
That's because investors often forget this simple axiom during raging bull
markets: valuation matters.
Not Just Pieces of Paper
"The value of any stock, bond or business today is determined by the cash
inflows and outflows - discounted at an appropriate interest rate - that can
be expected to occur during the remaining life of the asset." - John Burr
Let's think about what a stock is for a minute: it is a share in the ownership
of a company. So as a shareholder, you're really a part owner in a business.
And whether it is a lemonade stand or a multinational conglomerate, the
intrinsic value of that business is the present value of its future cash
Granted, forecasting cash flows for almost any business is difficult and often
fraught with error. However, decent proxies for discounted cash flow analysis
are valuation multiples on earnings and cash flow. Study after study has shown
that stocks with low price/earnings or low price/cash flow ratios have
outperformed the market. Meanwhile, those with high P/E or P/CF multiples have
Good Business, Bad Stock
"Obvious prospects for physical growth in a business do not translate into
obvious profits for investors." - Benjamin Graham
Simply buying a stock just because you expect its cash flow to grow at a high
rate over time isn't enough. You have to buy it at a reasonable price.
Keep in mind that in most cases the market has already "priced in" a company's
growth. And if its growth fails to meet (or even sometimes exceed) the
market's expectations, then its stock can get pummelled. In other words, a
sky-high P/E multiple will eventually contract if a company misses those lofty
earnings expectations or when (not if) growth inevitably slows.
Examples like this occur every earnings season.
The Power of Earnings Estimate Revisions
"Earnings estimate revisions are the most powerful force impacting stock
prices." - Len Zacks
Our research here at Zacks has shown that stocks with rising earnings
estimates have significantly outperformed the market year after year, while
stocks with falling earnings estimates have underperformed the market.
Why is this?
Think back to what the intrinsic value of a business is: the present value of
all future cash flows (or earnings). So if earnings estimates rise, then the
value of that business rises. Conversely, if earnings estimates fall, then so
does its intrinsic value.
However, our research has also shown that value stocks with rising earnings
estimates perform much better than expensive stocks with rising earnings
Stocks to Avoid
I ran a screen in Research Wizard based on the following criteria:
oPrice to Cash Flow > 40
o12-month Forward P/E > 30
oZacks Rank >= 4
oCurrent Price > $5
I backtested this screen with a 24-week holding period over the last 10 years.
The results show that a group of stocks that fit this criteria significantly
underperformed the S&P 500 and actually provided a negative return.
So what are some stocks to avoid based on these criteria?
Here are 4 names from the list:
Amazon (Nasdaq:AMZN-Free Report)
Price to Cash Flow: 45x
Price to Forward Earnings: 166x
Zacks Rank: 4
I get it: online retail is growing rapidly, and Amazon is the juggernaut in
this space. But who doesn't know that already? If you're buying Amazon at
these prices, then you're implicitly saying that the stock market isn't
factoring in enough growth for this company. That's a very bold statement.
Bulls may argue that Amazon is investing for tomorrow and doesn't care about
turning a profit today. That might be fine for a new company in a new
industry, but Amazon is 20 years old now. When will tomorrow finally come?
It looks like investors might be starting to lose their patience. Shares of
Amazon are down more than -12% since the company's Q4 results fell short of
expectations on both the top and bottom lines. Unsurprisingly, earnings
estimates have come down considerably too.
Medidata Solutions (Nasdaq:MDSO-Free Report)
Price to Cash Flow: 99x
Price to Forward Earnings: 150x
Zacks Rank: 4
Medidata Solutions provides cloud-based solutions for clinical research in
life sciences. These solutions allow its customers to increase the value of
their development programs by more efficiently and effectively designing,
planning, and managing key aspects of the clinical trial process.
Revenue has been growing at a healthy clip for Medidata, but its stock price
has grown even faster. And consensus estimates have fallen significantly
following the company's latest earnings report on February 6. With shares
trading a frothy 150x forward earnings, investors should strongly consider
investing their money elsewhere.
Qualys (Nasdaq:QLYS-Free Report)
Price to Cash Flow: 87x
Price to Forward Earnings: 471x
Zacks Rank: 5
Qualys provides cloud security and compliance solutions for corporations.
Similar to Medidata, the company has delivered strong revenue growth. But by
the company's own non-GAAP EPS numbers, earnings were flat in 2013. And
operating cash flow increased by a fairly tame 15%.
Meanwhile, consensus earnings estimates have fallen since the company's Q4
earnings report on February 10, sending the stock to a Zacks Rank #5 (Strong
LinkedIn (NYSE:LNKD-Free Report)
Price to Cash Flow: 132x
Price to Forward Earnings: 1,087x
Zacks Rank: 4
Social media is hot right now, and LinkedIn is becoming an important part of
the job market. Nobody denies that. But LinkedIn is expected to barely turn a
profit this year. And earnings estimates for both 2014 and 2015 have plummeted
since the company reported its Q4 results on February 6. It is a Zacks Rank #4
LinkedIn is down more than -20% from its 52-week high set last September. But
does this stock really look like a value with a forward P/E ratio over 1000?
No matter what the stock market is doing, stay focused on the underlying value
of the business you're invested in. Don't buy a stock just because you think
its earnings are going to grow. It's not that simple. The market has likely
already priced that growth in, especially during bull markets. Look for
reasonably priced companies who are exceeding expectations and avoid those who
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