There are hundreds of overpriced stocks.
The market has been on a bull run for 6+ years so I’m not going to shock anyone when stating that there are some ridiculously overpriced stocks.
I will admit upfront that I don’t short stocks. Even when markets get high. Even when something looked like a perfect short, I never found it in me to short.
Maybe it’s because of what Buffett has said.
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 without having shorted anything. And instead of chasing activity by looking for things to short, I prefer to simply take it as an exercise of what I would theoretically short and learn from the sidelines.
Shorting requires some of the most rigorous research. The core concept of successful shorting from the likes of Jim Chanos, Citron Research and Muddy Waters, is that the company has to have a fundamental problem or face headwinds.
It’s not enough to short based on valuation as the market can remain wrong longer than any investor can remain solvent.
However, here are some stocks that are wildly overvalued on price alone.
(This article was written before Yelp released earnings, however the analysis and conclusion is still the same.)
Online business review website and app.
- Recent Price: $51 ($45 after earnings -20%)
- What It’s Worth: $32 even with heavy optimistic assumptions. See below.
- No where near the required profitability for where it is trading
- Share dilution
- Heavy competition from Google, Expedia, OpenTable and even Facebook for local reviews.
Why I Don’t Like It and Why It’s Overpriced
First look at the following stats.
Just by these basic numbers, you can tell the company does not trade on fundamentals.
Any stock where earnings is close to zero but has a PE of over 3600 is priced for the future and perfection.
In the case of Yelp, an analyst EPS of $0.40 for 2015 is a PE of 129.
Using 2016 estimates of $0.87, a 2 year forward PE is 59.
Let’s put this another way.
Today, investors are willing to pay $3600 for every $1 of current earnings. In 2 years, investors must be willing to pay $59 for every $1 of current earnings.
Simply put, there are no fundamentals.
In trying to figure out what Yelp is worth, I use a handful of valuation methods to get an all around view so as not to get boxed into one mindset or valuation method.
And one simple method of valuing a stock using earnings is to use an adjusted Graham’s formula using the 2015 analyst earnings of $0.40.
To match the price of $51, a growth rate of 120% is required for the next year.
However, revenue growth and EPS growth hasn’t been able to match this.
- Revenue growth for 2013 was 70%.
- Earnings growth has slowed down and no where near the required 120% level.
Even with very optimistic assumptions of profitability and growth, the maximum value I get is $32.
- $540m revenue
- 8% operating margins
- EBIT multiple of 40x to 45x
Yelp has been receiving a lot of slack about how it also publishes reviews, overly punishing businesses by display negative reviews over positive ones.
It’s no wonder that their aggressive advertising practices does not sit well with local businesses and has induced two investigations by the FTC.
No action was taken against Yelp, but the fact that the FTC even had to investigate the company twice shows how many complaints they get from their core customer base that they should be pleasing.
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Relentless Insider Selling
A picture says a thousand words.
The selling continues on and on.
There are many reasons for selling, but when insider activity is dominated by selling, it doesn’t breed confidence to investors.
The main problem with Yelp is its valuation.
The product is great for consumers, but the satisfaction rating among existing business owners is not where it needs to be in order to grow quicker.
It’s fallen 20% after earnings, but there is still more room to fall. Even with my aggressive assumptions, the maximum value I can place on Yelp is $32.
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