3 Overperforming Stocks That Won’t Stay That Way for Long

Last year, U.S. equities could only be described as volatile and underperforming. The macroeconomic environment, intensified in part by Russia’s invasion of Ukraine and China’s “zero Covid” policy, led to elevated commodities prices worldwide. Inflation reached a point where the U.S. Federal Reserve had to act by raising interest rates seven consecutive times. The Dow Jones, S&P 500 and Nasdaq ended 2022 at -8.8%, -19.4% and -33.1%, respectively.

However, stocks roared into 2023 and have been outperforming expectations. Investors began to pour back into the stock market at a record pace in search of bargains after the stock market’s worst year since 2008.

The ensued recovery has resulted in substantially higher valuations, especially in the technology sector. But was the recovery justified? The macroeconomic environment has not improved much — interest rates remain between 5% and 5.25%, inflation is still stubbornly persistent, and there is ongoing turmoil in the U.S. banking sector.

These are signs of an economy that is in dire straits, and there will be negative effects on many companies’ business models, despite investor optimism. Still, some companies that have outperformed will be more exposed to an economic slowdown than others.

Nvidia (NVDA)

Shares of the well-renowned graphics card designer are up nearly 100% for the year, but the current economic environment threatens Nvidia’s (NASDAQ:NVDA) business outlook.

During the Covid-19 pandemic, Nvidia and other technology companies received a huge boost as people around the world were forced to stay at home. Many had to purchase an array of consumer electronics to work from home. As a result, Nvidia’s revenues are up 62% and its share price has nearly quintupled since the beginning of the pandemic.

However, soaring inflation and worsening economic conditions have put a dent in consumer demand, especially for consumer electronics products. From 2021 to 2022, NVDA only saw revenue grow 0.22%.

On the other hand, tensions in the Taiwan Strait do not appear to be subsiding, and a large portion of Nvidia’s processors are manufactured by the Taiwan Semiconductor Manufacturing Company (NYSE:TSM). If there is a conflict in the Taiwan Strait in the future, not only would one of the world’s most important trade routes be compromised but also TSMC’s factories could be in jeopardy.

Nvidia is up 0.18% for the week, and the company will be reporting earnings on May 24. The 12-month average price target is $283.57. That does not imply much upside from the current price of about $282.

EverCommerce (EVCM)

EverCommerce’s (NASDAQ:EVCM) share price has outperformed the market and has increased by approximately 63% YTD, mostly thanks to equities’ stupendous start to 2023. The company provides integrated business management solutions for service-based small- and medium-sized businesses (SMBs) in the United States and abroad.

From a purely financial standpoint, EverCommerce appears to have decent fundamentals. In 2022, the company grew revenue by 27% and ended the year with $620 million in revenue. Gross margins were at 65%. Therefore, the company easily passes the Rule of 40.

However, EverCommerce’s 2022 contribution margin, which takes into account marketing expenses, tells a different story. At the end of 2022, the company’s contribution margin was 46%, which is much less stellar. SaaS businesses whose customer set are SMBs need to invest heavily into marketing, but these investments also negatively affect their bottom-line profitability. Couple all of this with the fact that many economists are predicting a recession for the U.S. economy, albeit later than previously thought, and the company’s outlook looks bleak.

SMBs tend to fare terribly during economic slowdowns compared to larger, more established enterprises. If these businesses see a slowdown in their overall revenue, then it’s likely they will go out of business, potentially putting pressure on EVCM’s revenue growth and margins.

There are rumors EVCM is seeking a buyer, and this injected some life into its share price. However, given the potentially difficult times ahead, the mergers and acquisitions (M&A) processes may stall. The average 12-month price target given to EVCM by analysts is $12.69, which leaves no potential upside for the company at current prices.

e.l.f Beauty (ELF)

Shares of e.l.f. Beauty (NYSE:ELF) have surged 300% over the past 12 months. The cosmetics multi-brand has made numerous investments to rid its products of their prior reputation as “cheap and disposable.”

Effective social media-driven marketing campaigns, increased sales channels, and recent investments in research and development (R&D) have allowed ELF to create a strong customer base. Given the robust fundamentals at play, investors poured into the stock, and those who have been holding for a longtime have been handsomely rewarded.

Unfortunately, even companies with sound fundamentals could face headwinds in this market. The so-called lipstick effect may help shield e.l.f Beauty’s revenue from potential decline. However, the company’s EV/EBITDA multiple, which currently sits at 56.6x, is more than 2x where it was a year ago. That could place massive selling pressure on the stock in the near term as long investors cash out on their investments.

ELF will be reporting earnings on May 24. Analysts have given ELF an average 12-month price target of $96.18. While that does imply upside potential, the possibility of a steep selloff is very real.

On the date of publication, Tyrik Torres did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.