Valuation has been a persistent theme for investors throughout much of this year. Rising stock prices are a natural part of a bull market, and during periods of volatility, it’s common for investors to start looking for stocks that sell at a discount from their prior highs. However, with asset values at record highs, there are some stocks that continue to be overvalued and are selling at prices far above their intrinsic value.
The intrinsic value of a stock is the price that a share of the company “should” be worth. There are a number of different formulas that investors can use to calculate a company’s intrinsic value. For the purposes of this article, we’ll keep it simple (albeit imperfect) and compare a company’s stock price with the company’s book value.
Book value per share is an indicator of a company’s net asset value on a per-share basis. When a stock has a lower book value per share in relation to its current price per share, it is generally considered to be a sign the stock is overvalued. Here are three stocks that are trading well above their book value and, more importantly, have other less obvious risks.
Is this stock a case of mistaken identity?
The first stock to look at is Shopify (NYSE: SHOP). As of this writing, Shopify is trading at $321.39 which is just under 17 times (16.97) its book value of $18.94 per share. The case for SHOP’s future growth is that it is adding fulfillment services which will expand its addressable market and give the company another source of revenue. More revenue means more profit which can justify investors bidding up the stock. Theoretically, that leads to a higher valuation. Or does it? The concern is that future growth for SHOP is starting with shares that are already trading at a premium. Another concern is that entering the fulfillment business and becoming profitable at it are two different things. Brick-and-mortar retailers such as Walmart and Target have spent multiple billions and are still playing catch up to Amazon. Analysts are projecting the fulfillment part of SHOP’s business will not be profitable until 2023. As part of an emerging trend known as the coordinated economy, Shopify seems to be appealing to investors and consumers as a decentralized, cheaper Amazon. The question becomes is this a case of investors betting on what Shopify is or what they want it to be? That question may be better answered if the economy starts (or continues depending on your outlook) to soften. Analysts may be voicing their opinions as the consensus outlook for SHOP’s stock has been downgraded from Buy to Hold with a consensus price target of $324.92.
Will this stock be a casualty of the trade war?
Another stock that is telling a cautionary tale is Roku (NASDAQ: ROKU). Roku is selling at over 43 times its book value of $2.23 per share. As one of the dominant names in the streaming world, Roku would seem like a safe bet for future growth. Its advertising platform, which makes up about two-thirds of the company’s business, will continue to benefit as more consumers cut the cord and additional streaming services competing for viewers. The challenge for Roku is the other third of their business – the Roku sticks that deliver its service and the smart televisions that have Roku pre-installed. These devices are made in China and company insiders were expressing public concern about the effect of the trade war and that was before the Trump administration announced their intention to extend the tariffs. However, the company may have more reason to be concerned about the decision made by electronics maker TCL to sell off the majority of their business including their television manufacturing – specifically Roku TVs. In the long term, Roku’s stock may just be scratching the surface of its potential. But investors have become accustomed to ROKU’s share price vastly outpacing the market and should prepare for an inevitable slowing of share price appreciation.
The sky is not the limit for this stock
Finally, let’s take a look at Etsy (NASDAQ: ETSY). Etsy and Shopify are cruising down the same river, but they are in very differently sized boats. Etsy is a niche player and does very well, even weathering the entrance of Amazon into its crafting market. After successfully raising their seller fees in 2018, the company saw a big lift in revenue, margins, and stock price. However, with prices well off their 52-week highs, investors seem to be rightfully questioning the company’s future growth prospects. Even with that correction, the stock is still trading at over 16 times book value. In their most recent earnings report, the company came in just under analysts’ revenue estimates and met their EPS estimate. The consensus price target of $71.46 comes in just under their 52-week high suggesting that analysts are figuring Etsy’s stock may have already seen its best days.
Don’t ignore the caution signs in this market
During a bull market like the one we’re experiencing, it’s not uncommon for many stocks to get “ahead of their skis”. In fact, just based on book value, you could make a case that almost every stock is overvalued.
But as the saying goes, you can’t fight the tape. There are many stocks that will brush aside concerns about valuation and continue to march forward. You have to stay in the market. But your quest for growth doesn’t mean you can’t proceed with caution. And that’s the case with these three stocks.