Baron Rothschild once said, “I made a fortune by selling too soon.” Investors in stocks today might consider this advice when looking at shares of Workday Inc (NYSE:WDAY) and CONN‘S, Inc. (NASDAQ:CONN). Why would anyone group Cramer’s favorite Jersey retail chain and a cloud computing stock in the same article you may ask? Well, these stocks both have extreme optimism and exuberance priced into their shares and are extremely speculative at current valuations. Investors in these two stocks may want to consider simply selling soon.
Workday Inc (NYSE:WDAY), having benefitted from the current Cloud Computing craze, picked the exact right time to go public. Not since the first technology bubble of the late 1990′s have investors blindly placed such unwavering faith in an idea like Cloud Computing in terms of raw multiples. So what is it that is so appealing about Cloud Computing for investors? For one thing, Software as a Service is expected to grow at a 19.1% compound annual growth rate over the next four years but I actually expect higher growth than that in this space.
Cloud Computing is a big deal, and is allowing me to type this article without a word processor. It’s as simple as that — this technology allows everything people do with software to be done at a lower price point via cloud. In addition to making software seemingly obsolete long term, the cloud can also store all of the medical records of a hospital and all of the data at the Treasury Department, for example, to be remotely stored without the need for physical documents.
Basically, the cloud is huge for data storage and record keeping as well as software. So it’s easy to see why stock market investors would love this industry and push multiples to the sky. Heck, in 1999 anything with a dot com at the end of it went to the moon despite the business realities or the individual business models of the companies these slips of paper represented. The rise of online stock trading and low commissions certainly is also in part to blame for such speculative and short term behavior. In addition, the psychology of market participants, motivated by fear and greed, helps push bubbles to the moon and then back to the linoleum floor.
Certainly, the gyrations of the banking system and the dissolution of Glass Steagall are a huge culprit in the bubble making and popping game that ends up costing investors so much money over time. The biggest reason in my view for the recent parabolic rise in salesforce.com, inc. (NYSE:CRM), Workday Inc (NYSE:WDAY), and CONN’S, Inc. (NASDAQ:CONN) is likely groupthink, easy money policy, the herd mentality of prop traders, and the fact that traders will chase high beta momentum stocks on margin during stock market rallies.
Workday Inc (NYSE:WDAY) is a lot like rival salesforce.com, inc. (NYSE:CRM) in that it provides cloud computing solutions to corporate clients. While I have written about the extreme valuations at salesforce.com, inc. (NYSE:CRM) in the past, that stock has proven (for now at least) to be relatively bullet proof when it comes to valuation concerns — at least up until now… Bears have tried and tried to smack the varnish off of the salesforce.com, inc. (NYSE:CRM) hype for years but to no avail — it doesn’t matter what the company announces, the shorts simply get squeezed over and over again, while the bulls point to top-line growth. The key to shorting such a pumped up “leading” stock is to wait for a confirmed breakdown in the overall market before casting out your short line — it never pays to drive the wrong way on a one way street, and individual stocks are 70% correlated to the behavior of the overall stock market.
Today, we have a somewhat centrally orchestrated overall market rally that appears to be a bit on the bubble side. Workday Inc (NYSE:WDAY) seems to be even more absurdly valued than its rival cloud stocks, trading at a whopping $10 billion valuation with no actual earnings to speak of or any meaningful revenue or cash flow data for longs to brag about. No, this recent IPO looks to me to be a “story stock” on serious performance enhancing drugs. While Workday Inc (NYSE:WDAY) is benefiting from being a “cloud story” and a “growth at any price” type of name, what really drives names like this is sentiment and hype.
With stocks like Workday Inc (NYSE:WDAY), investors are really only focusing on future growth and the price chart. As long as the price is moving “from the lower left to the upper right” the machines and traders will be long this “high beta” stock setting higher and higher stop loss orders which helps, along with scared short sellers, to create a price bubble in the name. I am certainly not bashing the company here, stock prices and the ownership interest in particular companies that they represent simply do not have much in common right now. In this type of late nineties environment you have the brave and the boisterous profiting from the trusting and prudent via overpriced share issuance and bubble-like speculation. The same thing was going on back in 2007 as well. What remains to be seen is how long the bubble can inflate this time around. Certainly, selling too soon is a good strategy as you can never go broke taking a profit.
Workday trades for a mind-boggling 33 times Sales (yes, 33 times SALES!) and 16 times book value. At least the market is totally efficient right now…
So, in essence, today you have this hot air balloon type of market where “the story” is more important than the homework — the investment bankers and rival companies who want to cash in on this red hot IPO market are certainly not complaining. While we can always blame people or ourselves for missing the party, the wise decision is to allocate your capital conservatively and keep your eyes wide open when playing the tremendous growth in Cloud Computing.
On the opposite side of the spectrum you have Conn’s, which is Cramer’s favorite department store in Jersey. Conn’s was a heavily shorted stock that became incredibly undervalued back in the dog days of 2008 and 2009. Back then, the shorts controlled some 30% of the float and it looked unlikely that Conn’s would avoid bankruptcy protection. The shares traded for a fraction of tangible book value, and fetched just $3 to $4 per share. Back then I owned some shares as an asset play. I figured it could turn around much the way Dillards did after blowing up in 2008. I never thought, however, that Conn’s would today fetch a 34 earnings multiple and trade for $44 a share, or a 1000% gain from the 2009 price tag.
Today, shares look overvalued and the chart seems stretched. In fact, Conn’s is up 300% over the past year and change — it’s probably time to start shorting the name here, or at least sell it soon! At a 3.2X price to book and a 17 EV/EBITDA ratio the momentum may continue but investors should sell and leave some of the upside on the table. Speculators playing the “raising stop loss orders” game will always be faster on the draw than the average investor.
In short, with valuations of 25 times earnings and 3 times book value at Conn’s, there is room for some skepticism after the stock ran up over 1000% from the bear market lows of $3 when 30% of the float was sold short. However, the forward PE on Conn’s is actually quite reasonable at 12 times earnings. The thing that most concerns me with this stock is the ballooning accounts receivables (which were $76 million in the recent quarter while total earnings for the year were only $52 million) which can artificially juice net income in the short term but lead to real problems over the long term and is even a sign of liquidity issues. Essentially, this company has flat sales over three years but 400% profit growth.
Obviously, the bears were taken by surprise on this thing and I did actually dipped my toe in this back at $4 a share on the long side (I think I sold this for like a 4% gain, lol). So to see this at $40 a couple of years later makes me wonder if some of that growth in receivables is a sign of trouble ahead, or maybe it’s just my sellers remorse. The gross margins at Conn’s have expanded favorably over the past few years, and this is the main reason for the rise in profitability and share price. Insiders have certainly been net sellers here over the past few years, but that could simply be the sign of conservative investing.
The article Two Stocks To Sell Soon originally appeared on Fool.com and is written by Nick Southwick.
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