3 Overhyped Stocks to Sell in May Before They Crash & Burn
The stock market has been on an amazing run. In particular, growth and technology stocks have surged over the past year.
With the market in general rising strongly, there have been all sorts of companies that have delivered outsized gains and sparked overwhelming investor enthusiasm. Thanks to the prominence of momentum investing strategies, oftentimes stocks that are already surging tend to keep going higher as traders follow the trend and cash in.
However, there is real risk buried within these sorts of huge moves. Traders can sometimes forget about valuation, but fundamentals do reappear sooner or later.
For these three overhyped stocks to sell right now, their share prices have leapt far ahead of the underlying value of their businesses today. This exposes them to severe downside risk.
Market momentum could reverse due to higher interest rates, geopolitical risk, and the upcoming presidential election. Traders might wish to take some chips off the table, and these three overhyped stocks to sell are a great place to start.
Spotify Technologies (SPOT)
On paper, Spotify Technologies (NYSE:SPOT) has an exceptionally attractive business model.
The idea of effective global near monopoly on music streaming seems rather attractive. Investors made a ton of money on Netflix (NASDAQ:NFLX) over the years. In some ways, Spotify seems like an even better business as there are fewer competitors in audio than video and Spotify doesn’t have to spend as much on content creation as Netflix.
I am quite familiar with Spotify’s bull case, as I was a longtime shareholder of the company. However, I recently sold my position and believe SPOT stock is now significantly overvalued.
My change of heart came because the business’ economics never developed in the way I had expected. In 2018, Spotify had a gross margin of 25.7%. In 2023, it produced a gross margin of 25.6%. This means that Spotify was not able to improve its core profitability even a fraction over the past five years.
I had assumed that Spotify was going to become more profitable, negotiate better deals with record labels, and achieve operating scale as the firm’s subscriber base increased. Instead, Spotify has struggled to get any meaningful concessions from the record labels. And its podcasting and other ancillary businesses didn’t take off in the way bulls had hoped for.
Spotify remains a low-margin business that struggles to achieve positive earnings per share on a consistent basis. In fact, Spotify’s best year — on a net income basis — was back in 2021, and its operating losses have widened since that point.
Even the pandemic-driven boom in digital services and subscriptions failed to meaningfully move the needle for Spotify’s profitability. Perhaps Spotify will eventually demonstrate the powerful network effects that investors were expecting. However, with SPOT stock having quadrupled from the 2022 lows without much real improvement in the underlying business, shares are an extremely risky bet today.
Nu Holdings (NU)
Nu Holdings (NYSE:NU) is a Brazilian FinTech company that operates a digital banking operation primarily in Brazil, Mexico, and Colombia.
Its unique value proposition is in making banking affordable to the middle and lower classes.
In Brazil and many Latin American countries, the traditional banks tend to only want to do business with wealthy clients. This left a large unbanked community. A 2021 survey, for example, found that just 10.5% of Colombians had a credit card, and that this number has actually been falling over time.
Fintech companies such as Nu have been able to come in with no fee debit and credit card offering and rack up large numbers of monthly active users. Nu enjoyed tremendous success in its core Brazilian market and recently it has expanded into other Latin American countries.
It remains to be seen if the expansion in those international markets will work as well as the Brazil business did. There’s more competition abroad, and Nu doesn’t have the same first mover advantage that it did when it launched in the Brazilian market a decade ago.
Regardless, investors are enthralled with Nu’s growth rate and furthermore, unlike many tech firms, the business is already profitable. There’s a lot here to like.
Unfortunately, the valuation is a total showstopper. Shares are trading for more than 50 times trailing earnings which is a pretty remarkable P/E ratio for a banking operation. In addition, Nu shares are trading at 8.9 times book value, which once again you almost never seen in the financial space.
Nu is growing its client base rapidly. But because the average account balances are quite small, the overall business will probably take a few years to scale up profitability at least compared to the legacy Latin American banks which usually trade at single-digit P/E ratios. In other words, investors have gotten way too excited for NU stock and its valuation is unsustainable.
Palantir Technologies (PLTR)
Palantir Technologies (NYSE:PLTR) is a big data analytics and consulting firm. It can sift through huge amounts of information and come to actionable conclusions for its clients. These include governments and intelligence agencies, Fortune 500 companies, and the like.
However, big data analysis isn’t necessarily all that compelling of an offering on its own. What’s made Palantir stand out is its charismatic CEO, Alex Karp, and the investor perception that the firm has cutting-edge information, analytical practices, and governmental connections that make it stand apart from its rivals.
There’s plenty that can be debated and discussed on these points. Palantir bulls have great confidence in the firm’s technical capabilities. Short sellers are substantially less impressed, with one critic calling the firm an “AI imposter“.
PLTR stock had slipped to all-time lows in 2022 as it had failed to live up to its initial enthusiasm.
However, shares have taken off once again on hopes around artificial intelligence. It’s easy to add the phrase AI to all sorts of complicated software operations and programs. Execution, however, can be trickier.
Perhaps Palantir is going to emerge as a leader in AI. But possibly it is using the AI hype cycle to put a glossier finish on what is essentially a high-powered data analytics and consulting operation. Time will tell. In any case, Palantir shares recently fell following an earnings report which failed to live up to expectations.
Palantir certainly has a solid business and many satisfied clients. However, investors have assigned way too high of a premium to the shares on the questionable assumption that Palantir will be a world-changing company. When, in fact, it may be more akin to a consulting shop. PLTR stock seems exceptionally overvalued at 65 times forward earnings. That’s doubly true given the firm’s recent lackluster earnings report.
On the date of publication, Ian Bezek 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.
