After two years of suspended disbelief, the markets are finally returning to some semblance of rationality. Need evidence? Cathie Wood – the tech investor who has been pouring other people’s money into unprofitable stocks with sky high valuations — says that the market is acting “irrationally.” Thank goodness. Now is the time to back to fundamentals and look for stocks to short.
I lived through the Dot-Com Bubble, so I remember when people were acting with total disregard for fundamentals. Over the last 23 months, that religious euphoria that “this time is different” bled into everything. Now, we have expectations for higher interest rates. We’ll actually have a number to use in discounted cash flow analysis. We now have a reason to short stocks again.
We can do something pretty simple and take direct aim at companies that have completely bonkers valuations. The time couldn’t be better. Broader market momentum is negative, and it appears that even the S&P 500 is facing a potential increased selloff that might lead to outright capitulation in some “growth” stocks.
With hedge funds dumping tech stocks at a frantic pace (remember, the ARK Innovation ETF (ARKK) is a proxy for hedge fund activity), it’s time to join the party. Today I’ll let you in on a simple way to take aim at these overvalued stocks.
A Simple Metric
If you want to take a shot at overvalued companies, you only need one metric. “Price to Revenue” – also known as Price to Sales.
A lot of people like to evaluate price-to-earnings ratios, but price-to-revenue gives you a better understanding of just how expensive a stock might be. Profits can bounce around a lot for some of these tech firms, but revenue is the constant that so many of the venture-style investors love to tap. The argument goes that so long as the companies are growing revenue, then they can stop reinvestment and boost profits. That’s a pretty lousy argument, but I’ve heard it my entire career.
The fact that some investors anticipate that revenue will simply multiply at a breakneck pace forever is a sign that they’re just trying to sell some of these companies to the next bag holder. Well, right now, there are a lot of people holding the proverbial bag.
Prior to the COVID crisis, investors could do pretty well shorting a basket of stocks that were trading at a price-to-revenue multiple over 30. But when COVID came along and the Fed increased the money supply by several trillion dollars, fundamentals went out the window.
With rate hikes coming, the market is having a tantrum. Well, one might call it that. I’d refer to this situation as the “Great Sobering” – a fiscal hangover that has been months in the making.
Which Stocks to Short
Now is the time to start looking for cheap ways to short these stocks. My recommendation is to go all the way out the put options chain for about three or four months and find the option that is trading for about $1.00. This is a cheap way to trade a basket of these. If just one really hits and the bottom falls out, it can pay for the entire basket.
I expect that funds will continue to slowly dump these stocks, and they’ll use any short term pops to exit tranches of their positions. Don’t be fooled by any headfake here.
|Symbol||Company||Current Price||Industry||PS Ratio|
|TTD||The Trade Desk||$74.78||Software||33.01|
We’ll be back tomorrow to talk about earnings season.