Foolish me. I went out of my way to say that I agreed with CNBC’s Jim Cramer on how to address the worst-performing stocks in the S&P 500 in 2021. But yesterday Cramer was back at it – talking about how the markets might find a bottom in tech. Knowing that he’s a perma-bull for all things buying, I wouldn’t be surprised to see him recommending a number of tech stocks on his program tonight that recently pulled back due to cheap money.
Here’s the problem. We might only be in the second inning of a tech-driven selloff. A report yesterday showed that hedge funds are unloading tech stocks at their fastest pace in a decade. But keep something in mind.
The purpose of a market is to sell – and to do so at the highest price possible. This means that funds aren’t going to unload all of their stocks – under one order – at the same time. That would be an outright catastrophe.
Instead, they’ll layer their sales over the coming weeks or months. They’ll use any short-term gains or rebounds in the stock as an opportunity to ditch some additional shares. They’ll take advantage of upgrades by analysts or earnings reports to sell, sell, sell. That’s the purpose of the market. So, make sure that you’re guarded about what you buy.
Valuations Return to the Conversation
We are about to enter a great year of price discovery – a process where the markets attempt to determine a reasonable or fair valuation for stocks. This happened in the wake of the 2000 Dot Com Bubble. After years of cheap money, low-interest rates, and wild speculation, higher interest rates will tame irrationality over time. This is how markets are supposed to work.
It’s just been two solid years of insanity – where cheap money made unprofitable companies into nonstop momentum buys. Well, we witnessed a selloff yesterday that suggests that rationality will return. That the collective delusion of these 24 months will eventually sober American investors once again.
This is something that has been on my mind for a long time. Prior to the COVID-19 crisis, I had a very simple strategy to short stocks that were overvalued. I simply chose stocks that traded above a price-to-revenue ratio over 30. In January 2020, the stock with the highest price-to-revenue (price-to-sales) ratio with sizable volume was Zoom Communications (ZM).
But then came COVID. And then came a wall of cheap money. And Zoom became the darling stock of early 2020 – long before the memes or gaming stocks.
Well, once the Fed did start to signal it was time to raise rates and taper its balance sheet, Zoom has experienced a significant selloff. Shares have fallen from north $400 in August to under $178 today. Funds walked away from this stock in droves, while Wall Street kept recommending it to retail investors. Wall Street still has a $260 price target on it.
The stock is STILL expensive. It’s trading at 13x sales and trades at a buyout multiple north of 38. What does it do that almost any other company in the virtual conference space doesn’t do? Well, someone should know that answer, but it’s not me. There really isn’t any significant competitive advantage here.
The same can be said for a lot of companies that are trading at very high ratios and show little profitability. MongoDB (MDB), Cloudflare (NET), Datadog (DDOG), and ZScaler (ZS) are all trading at P/S ratios north of 30 and are unprofitable. While they’ve come down sharply from highs in 2020, there still could be much more selling to come.
Don’t be the person holding the bag on these stocks. We’ll catch up again tomorrow. It’s time to talk about F & Z Scores once again.