Dozens of companies delivered multi-fold returns over the last year, creating more than a few overvalued stocks. For instance, GameStop (NYSE:GME) skyrocketed by 1,700% in late January on the power of retail investors at the Reddit group r/WallStreetBets. Despite its recent tumble, GME stock is still holding on to 200% year-to-date gains.
While the broad-based rally in the overall stock market is backed by fundamentals, there are stocks from good businesses that have run ahead of fundamentals. Investors need to avoid these overvalued stocks.
Let’s discuss four stocks that are overvalued and can witness a relatively sharp correction. I am not focusing on speculative stocks. Rather, these are stocks that can be considered for medium to long-term investments after a correction.
The following are the overvalued stocks to avoid (for now).
Overvalued Stocks To Avoid: Plug Power (PLUG)
There seems to be no end to the rally for PLUG stock. Exactly a year ago, the stock was trading at $4. The stock skyrocketed to $66 and valuations look stretched in the near term. Even if the company has a robust growth outlook for the coming years, PLUG stock is the first in the list of overvalued stocks to avoid.
However, it’s a stock that’s worth keeping in the radar for exposure at lower levels.
If we look at analyst estimates, the average stock price target for PLUG stock is $66.80 and the median price target estimate is $76.50. Therefore, the upside might not be significant in the near term. In particular, with Plug Power announcing another stock offering of $1.5 billion, the stock is likely to trend lower on equity dilution.
From a business perspective, there have been big developments for the company in the last few months. I see the company’s partnership with South Korean SK Group as a potential growth catalyst. The partnership intends to accelerate hydrogen economy expansion in Asian markets. The partnership with Groupe Renault will help in making inroads in the European fuel-cell powered light commercial vehicle market.
Recently, Plug Power also raised the guidance for the current year and 2024. However, most of these factors are discounted in the current price. The stock needs to take a breather before the next rally.
PINS stock is another name that has surged in the last year and looks overvalued at a trailing price-earnings ratio of 201.5x. There is no doubt that the company’s earnings growth has been robust. For the current year, earnings growth is expected at 61.2%. However, the P/E-growth ratio is still over 2x, and that implies that PINS stock is overvalued.
At the same time, the pandemic has accelerated online business growth. This trend is likely to sustain in the coming years. I would look at PINS stock at an attractive investment option on a 20% to 25% correction.
For the third quarter of 2020, the company reported average revenue per user (ARPU) of $3.85 in the United States. For the same period, global ARPU was 21 cents. I see significant room for growth in global ARPU. That’s likely to be a top-line and cash flow driver.
The company’s adjusted EBITDA has also been relatively volatile in the last four to five quarters. Steady EBITDA growth and EBITDA margin expansion are stock upside triggers once valuations look reasonable.
Overall, the company’s monthly active users have witnessed healthy growth. The business model is attractive, but a good business is not always a good investment. Investors need to wait with patience in the sidelines. The shares will be up for grabs at attractive levels in the foreseeable future.
AI stock, which was listed in December, was priced at $42. Currently, the stock trades 235% higher at $145. After the big rally, the stock looks overvalued. Recently, JPMorgan initiated AI stock with a “underperform” rating and a price target of $84. I will not be surprised if the stock corrects to around $100 levels.
C3.ai is an enterprise AI software company that provides software-as-a-service. The company’s software application can be deployed on Microsoft (NASDAQ:MSFT) Azure, Amazon (NASDAQ:AMZN) Web Services, Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google Cloud, IBM (NYSE:IBM) cloud, among others. The company believes that the addressable market for its AI software will be $271 billion by 2024.
The long-term outlook might be bright. However, current valuations are far ahead of fundamentals. For the last financial year, the company reported $157 million in revenue and a net loss of $69.4 million. The company is yet to achieve profitability at operating level and trades at a market capitalization of $13.4 billion.
Among the positives, the company claims to have a first-mover advantage with a patented AI suite. The company has a subscription-based revenue model, which ensures revenue visibility. C3.ai also has a quality customer base that includes the likes of Baker Hughes (NYSE:BKR), AstraZeneca (NASDAQ:AZN) and LyondellBasell Industries (NYSE:LYB), among others.
Overall, AI stock would be in my list of overvalued stock. At the same time, I would keep the stock in the radar. A sharp correction would be a good opportunity to consider some exposure.
TWLO stock would also be in my list of overvalued stocks that needs to be avoided at current levels. Currently, 24 analysts offering a 12-month price forecast for TWLO stock have a median target of $377.50, which is 5% less than TWLO stock’s current price. Therefore, the upside potential is insignificant, and a sharp correction is very likely.
The company’s top-line growth remains robust but has decelerated on a relative basis. For the third quarter, top-line growth was 52% on a year-over-year basis as compared to 75% the previous year. Further, Twilio continues to report losses at operating level. For the third quarter, the company’s loss from operations was $15 million. Even for the last quarter of 2020, the company guided for operating level losses.
Among the positives, Twilio has continued to add customers at a healthy pace. As of September, the company reported 208,000 active customer accounts, which is a 21% increase from the previous year. The company also completed a follow-up public offering for total proceeds of $1.4 billion. This provides flexibility for organic and inorganic growth.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored more than 1,500 stock specific articles with focus on the technology, energy and commodities sector.