Speaking about Amazon.com, Inc. (NASDAQ:AMZN), the business is amazing; the company has built a rock solid competitive position in online retail, while at the same time it expands to other areas with big potential like web services. Investors have been willing to look beyond current – lack of – profitability and focus on the long term opportunity, so the stock is trading at a stratospheric forward P/E ratio in the area of 75 times earnings estimates for next year.
The stock doesn´t necessarily need to come down, it can continue rising and trading at expensive multiples for years to come. But it does look very vulnerable in case there is a change in sentiment towards the company. If investors become less complacent about Amazon.com, Inc. (NASDAQ:AMZN), current valuation provides no downside protection, so a protective put may offer precisely that.
The same goes for a company like LinkedIn Corp (NYSE:LNKD), this is no smoke and mirrors social network stock; the company makes more than 50% of revenue from talent solutions, which is a much more proven and reliable business model than the typical pure advertising model most social networks are based on.
LinkedIn Corp (NYSE:LNKD) has more than 200 million global users, and nearly 16,000 companies pay for its services, so it has reached a level where it has become the unchallenged leader in the industry. And growth opportunities are far from over; LinkedIn Corp (NYSE:LNKD) estimates that the addressable market size for worldwide talent acquisition and staffing services is $27 billion, so the company has a lot to offer in terms of long term growth opportunities.
On the other hand, LinkedIn Corp (NYSE:LNKD) is trading at a sky high P/E ratio above 900; any sign of slowdown in growth or some other bad news could easily trigger a big selloff as the market prices the stock according to more modest expectations. This is another case in which a protective put may be a sensible idea.
Bottom Line
There is nothing magical or too sophisticated about protective puts, it´s actually quite similar to buying insurance on your positions for a limited time. This insurance may ultimately be worth it or not depending on what happens with the stock price, and no one knows for sure what the future brings.
But investing is not only about profits and losses; it’s also about finding a risk and return equation that fits your particular needs. Keeping this in mind, protective puts may be the way to go for many investors, especially in situations with high potential and above average risks.
Andrés Cardenal owns shares of Amazon.com. The Motley Fool recommends Amazon.com, LinkedIn, and Netflix. The Motley Fool owns shares of Amazon.com, LinkedIn, and Netflix.
