3 of the Most Overpriced Stocks with Real Downside Risk

Written by

Jae Jun

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I don’t short.

I like to copy Buffett in that regard.

Charlie and I (Buffett) have both talked about it. We probably had a hundred ideas of things that would be good short sales.  Probably 95 percent of them at least turned out to be, and I don’t think we would have made a dime out of it if we had been engaged in the activity.  It’s too difficult. The whole thing about ‘longs’ is, if you know you’re right, you can just keep buying, and the lower it goes, the better you like it, and you can’t do that with shorts. – Warren Buffett

The richest investor in the world got to where he is not having shorted a thing.

But with less to buy in the market, I want to turn my attention to see what was expensive.

Not to short or tell people to short, but just to see what was out there.

It seems like Goldman Sachs regularly releases a list of stocks with the most downside based on their valuations.

But since most of the stocks on their list is only overpriced by 15% or so, I figured I’ll give you my version of what overpriced is.

Searching for Overpriced Stocks

I started out by being lazy and looking up stock with a PE greater than 100.

Then I realized that some of these listed companies may have crazy valuations, but some of them had real legs to run.

So my search is based on a mix of unrealistic EV/EBITDA and negative ROE.

Fundamental numbers, valuation metrics, intrinsic value targets and certain charts come from the Old School Value Stock Analyzer.

Zilllow (Z)

Real estate information website and app.

Recent Price: $73.48

What It’s Worth: No more than $20 (even with extreme growth assumptions)

Downside: 80%

Why I Don’t Like it and Why It’s Overpriced

Regular share dilution by issuing shares.

Another round of share issuance was completed in the third quarter of 2013. Latest share count shows 39m shares outstanding compared to 30m in 2012. That’s a 30% increase of shares.

Insiders consistently exercise options.

Zero open market purchases. If insiders are unwilling to buy, it shows that the expectations baked into the current stock price is too expensive for the insiders.

Zillow Insider Transactions | Source: Morningstar

No proven operational history.

I get that Zillow is a growth stock, but is growth far more important than running the operations properly? The revenue growth is slowing down. Sales in the TTM is 49% higher than the previous year. A big drop from the 120% and 77% from first two year of being pubic.

High growth of intangibles.

A lot of acquisitions are being made to increase the offering. Zillow used to be a real estate pricing company, but with the web 2.0 revolution, it is offering more services and reaching into different markets to continue growth. Intangibles have gone from $76m in 2012 to $124m in the TTM.

Core business is unstable.

I am no real estate expert but from a business point of view, when a growth company, still in its early stages has to continue acquiring companies, there is no core strategy. It’s management trying new things and trying to expand into different markets to see what works.

Fundamentals are Through the Roof.

Call me blind or stupid, but I have no idea how to interpret these numbers to see Zillow’s upside.

Zillow Valuations | Source: Old School Value

Black Diamond (BDE)

Makes outdoor products and apparel. Think of Columbia Sportswear and The NorthFace.

Recent Price: $13.20

What It’s Worth: $7 max, and that’s because I’m nice.

Downside: 52%

Why I Don’t Like it and Why It’s Overpriced

Horrible business execution.

I don’t see a single shred of competitive advantage.

Margins have dropped considerably, the company is showing losses, it is losing money, and ROIC is negative.

Share Dilution.

A common issue with overpriced stocks is that shares are diluted constantly.

BDE Share Dilution

Share count has gone from 16.9m in 2009 to 32.4m TTM.

That’s a dilution of greater than 100% in 4 years.

Compare that to a company like Peerless Systems (PRLS) that has bought so much of it’s own shares that there will be nothing left soon.

PRLS Buys Back Shares Like Crazy

PRLS Buys Back Shares Like Crazy

Slow Moving Inventory.

Slow moving inventory isn’t necessarily a bad thing, but if it takes 1.5x to 2x longer to clear the inventory compared to competitors, there is a serious operating deficiency.

On the bright side, it shows that there is room for improvement and the stock could benefit, but margins are razor thin, and there is no room for mistakes for a small outdoors specialty retailer like Black Diamond.

Low Piostroski Score.

Black Diamond scores a 3 in the TTM vs a pathetic score of 2 in 2012.

A Lowly Piotroski Score

The three points come from

  • positive operating cash flow in the TTM
  • cash flow from operations greater than ROA
  • asset turnover is higher than in 2012

Yelp (YELP)

Online business review website and app.

Recent Price: $63

What It’s Worth: $10 even with crazy optimistic assumptions. See below.

Fundamentals are missing in the stock price

Playing around with the EBIT calculator, to even justify the current stock price, the normalized revenue has to be in the $1b range with 20% margins and an EBIT multiple of 20.

F.Y.I. revenue for the TTM is just $203.5m so you can see I am being generous.

Downside: 81%

Why I Don’t Like it and Why It’s Overpriced

There are no fundamentals.

The obvious thing to me is that Yelp does not trade on fundamentals. Recall when I wrote about Tesla.

Stock price = fundamentals + emotions

That’s what I’m seeing with Yelp at the moment.

If you were offered the chance to buy out a private business with Yelp’s numbers, what would you do?

I’d slap the seller in the face.

The numbers look worse than a non-profit company.

  • no profit
  • negative margins
  • share dilution
  • negative flow from operations
  • negative ROE (but surprisingly positive CROIC)

Relentless Insider Selling

It’s always been the trend for successful IPO’s.

YELP Insider Activity

YELP Insider Activity

Heavy Competition

One of the biggest competitors is now Google Maps. With so many Android devices already preloaded with maps, it’s a given that it will eat into Yelp’s mobile space.


Google maps and navigation is now integrated, and the natural flow when you try to look up the direction for a restaurant or a business is to type the address in. What happens now is that reviews pop up once you’ve entered your destination making it easy to decide on the spot rather than fire up the Yelp app.

A Word on Overpriced Stocks

The majority of companies that showed up in my search were related to software and the internet.

Maybe I’m just not smart enough to be able to see far into the future. These three stocks all have high downside risk and need things to continue going right.

The most surprising thing for me is that Jim Chanos took a long position in Yelp. One of the best short sellers buying Yelp makes no sense to me so I’m going to assume that my valuations are all wrong here.

But you know what the best thing is?

Despite how wrong I could be, I am not obligated to purchase or swing at any of these companies.

I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There’s no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it. – Warren Buffett

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