There’s value investing — buying shares of companies trading at reasonable valuations — and then there’s chasing momentum. Both strategies can be profitable. Cheap stocks are often cheap for a reason, and expensive stocks can get more expensive.
But that said, shares of Tesla Motors Inc (NASDAQ:TSLA), Zillow Inc (NASDAQ:Z) and Netflix, Inc. (NASDAQ:NFLX) are definitely trading at excessive valuations. That isn’t to say that they’re inevitably poised for a decline, just that the stocks appear to be priced for the most optimistic of outcomes.
Tesla needs to outsell the Chevy Malibu
Forget producing an electric car for a niche audience. At current levels, Tesla Motors Inc (NASDAQ:TSLA) needs to make a car capable of outselling General Motor’s longstanding family sedan, the Chevy Malibu, and it has just seven years to do it.
In 2012, the Chevy Malibu sold just over 200,000 vehicles in the US. A disappointment for GM, but still roughly 10 times greater than the number of Model S sedans that are expected to be sold this year.
But Bank of America argues, for Tesla to justify its present share price, it will need to sell somewhere around 320,000 vehicles per year in 2020. A tall order, and one that Bank of America doesn’t expect the company to live up to.
In short, for Tesla Motors Inc (NASDAQ:TSLA) to justify its current valuation, its cars must transition from being a high-end luxury to a mass market product. And while seven years might seem like a long time, it isn’t when it comes to cars — the Model S itself has been in production for over four years.
Zillow’s PE ratio is shockingly high
Zillow Inc (NASDAQ:Z)’s current price-to-earnings ratio is over 7,000 — 7,420 to be exact. That’s more than 400 times greater than the broader S&P 500 index.
Zillow has an interesting underlying business — it’s quickly becoming the go-to real estate website in the US. And given the ongoing recovery in the housing sector, this puts it in an attractive position.
Analysts have noted the company’s aggressive valuation, and have acted accordingly.
Analysts at Goldman Sachs downgraded Zillow Inc (NASDAQ:Z) to Neutral back in May, noting that the stock’s current valuation reflected any potential positive outcomes. Citi came to a similar conclusion earlier this month, initiating the stock with a Neutral rating, and arguing that the stock’s present valuation took into account the most bullish of outcomes.
Netflix needs to add subs — a lot of them
Netflix, Inc. (NASDAQ:NFLX)’s price-to-earnings ratio of 632 is certainly excessive, but relatively tame compared to Zillow’s. Yet, more crucial than earnings may be Netflix’s ability to add subscribers.
Netflix, Inc. (NASDAQ:NFLX) is at key stage in its ongoing transition to become an online TV network. The streaming giant has committed billions to content providers for original and exclusive content, and it needs new subscribers to make good on those commitments.
At the end of March, Netflix stood at just over 29 million US subscribers. This is significant as it’s near the all-important 30 million threshold, a number that HBO has long struggled (and failed) to break above.