Prudent investing can sometimes be a lonely pursuit. Value investing doesn’t get much air time from the financial media. Instead, it’s easy to get carried away with the hot stocks of the day.
Disciplined investing means following the ideas proposed by Benjamin Graham, whereby the investor diligently avoids paying too much for a stock’s earnings and dividends. Legendary investors such as Warren Buffett have invested like this their entire careers and made fortunes for themselves and their investors.
While it’s often easy for a value investor to spot a stock that presents an attractive opportunity, it can sometimes be much harder to pinpoint which stocks should be avoided. This is even more difficult when it involves admirable, extremely well-known businesses.
Three popular companies with overvalued stocks
It’s important to remember that even the best companies can amount to poor investments if their stocks are overvalued. The following are three stocks which, I believe, are just that. These companies rack up huge sales and sales growth from year to year, but are not consistently profitable and trade at exorbitant valuations.
Amazon.com, Inc. (NASDAQ:AMZN) is the online retailing juggernaut whose growth story is truly incredible. The company has grown to a market value of more than $120 billion. Amazon.com, Inc. (NASDAQ:AMZN)’s sales have grown at an amazing clip. To illustrate, consider that Amazon racked up 27% sales growth last year.
Another high-profile stock that the financial media is obsessed with is Facebook Inc (NASDAQ:FB). Facebook only began trading publicly last year, in what was one of the most widely-anticipated IPO’s in recent memory. Facebook Inc (NASDAQ:FB) generated more than $5 billion in revenue last year, up 35% from $3.7 billion the year before.
Not to be outdone, cloud computing solutions provider salesforce.com, inc. (NYSE:CRM) reported 35% growth in total revenue in its most recent fiscal year.
Great on the top line, not so on the bottom line
These companies have all demonstrated high sales growth. However, while top line growth has been fantastic, their lack of profitability is what concerns me.
Amazon.com, Inc. (NASDAQ:AMZN) lost money last year, despite its impressive revenue growth. That means it’s impossible to even derive a P/E ratio. But just for fun, over the past five years, Amazon’s most profitable year was 2010, when the company earned $2.53 per diluted share. That means that at current prices, Amazon.com, Inc. (NASDAQ:AMZN) trades for more than 100 times even those earnings.
While Facebook Inc (NASDAQ:FB)’s revenue growth sounds fantastic, it becomes less so when you realize that Facebook Inc (NASDAQ:FB)’s expenses more than doubled over the same time period. As a result, Facebook’s diluted earnings per share fell from $0.46 in 2011 to one penny per share last year. That means that new investors are paying more than 2,300 times the company’s fiscal 2012 profits.
As far as salesforce.com, inc. (NYSE:CRM) is concerned, its impressive revenue growth last year couldn’t stop its net loss from ballooning. The company lost $0.09 per diluted share in fiscal 2012, then lost $1.92 per diluted share in fiscal 2013.
The Foolish takeaway
Of course, none of this is an attempt to predict the future. That’s not what disciplined investing is about. A stock price can go anywhere. Any of these stocks could rise to $1,000 per share or more. But at the valuations these stocks trade for, investors are asking for trouble.