US stocks have been in a strong rally recently. All the major indices, including the Nasdaq 100, S&P 500, and Dow Jones, are at an all-time high. This performance has been driven by the low interest rates, quantitative easing, and the so-called irrational exuberance in the market.
Today, valuations are at their pre-global financial crisis bubble levels. For example, the Nasdaq 100 index has a price-to-earnings ratio of 40 while the S&P 500 has a multiple of 38.7. We also have several companies with a valuation of more than $1 trillion.
All this has led to inflated bubble stocks. This refers to a situation where companies’ valuations are not in line with their intrinsic values. For example, at the time of writing, Tesla has a market cap of almost $800 billion. That’s higher than all other global automakers combined. In this article, we’ll look at five bubble stocks that you should avoid.
Market cap: $18 billion.
The success of Tesla and the recent trend of environmental, social, and governance (ESG) has pushed more people to the electric car industry. One of the biggest winners in all this is QuantumScape, a company that is doing research of solid-state batteries. It hopes that in the next few years, more auto companies will be focusing on this type of batteries.
However, today, QuantumScape has not yet completed researching and developing the battery. In fact, it expects that its batteries will go into production in 2026.
QuantumScape has an ugly income statement. It does not have any income, but it lost more than $419 million in the past 12 months.
Yet, the company has a market value of more than $18 billion. This makes it one of the most overvalued companies in the world. Investing in it is a bit difficult because the company has just $80 million in cash, meaning that it will need to raise more money in the market. Also, there is no guarantee that its products will be successful.
Market cap: $81 billion.
TTM revenue: $489 million
The cloud computing industry is one of the fastest-growing in the United States. This has happened as more companies shift their processes from traditional data centers to the cloud. As a result, cloud computing companies tend to trade at a premium.
Snowflake is a cloud computing company that provides data warehousing services to customers from around the world. Some of its leading customers are Office Depot, Hubspot, Zendesk, and Rakuten.
Snowflake became a public company in 2020. It gained a lot of popularity because Warren Buffett was a leading investor in the firm.
Today, the company boasts a market cap of more than $81 billion. This is despite the fact that it generates only $489 million in annual revenue and that it is still making losses. In the past 12 months alone, it lost more than $420 million.
To be sure. Cloud computing companies tend to attract rich valuations because of their fast growth. But Snowflake’s valuation simply does not make sense because the company will need to experience triple-digit growth for a while.
Canoo Holdings (GOEV)
Market cap: $4.4 billion.
TTM revenue: $0
Canoo Holdings is another small company that recently went public. The company is in the electric car industry, but unlike Tesla, it has never delivered a car. It is building small cars that will be used in the cargo industry. Its current lineup has Canoo and MPDV models that are only available in preorder.
A $4.4 billion market cap is a lot of money. For one, the company is now worth more than GoPro, the company that dominates the action camera industry. It is also worth more than a company like Box, the cloud computing company that serves thousands of companies around the world.
In other words, in my view, we are in an electric vehicle bubble that will ultimately burst. Fortunately, we have history to look up to. In the late 199os and early 2000s, the internet was the place to invest in. As a result, investors piled into all types of companies with a dot com. When the bubble burst, only a few companies like Amazon and Google survived. The same thing will probably happen in the EV industry.
Zoom Video Communications (ZM)
Market cap: $111 billion
TTM revenue: $1.36 billion
The coronavirus pandemic pushed more people to work from home. Many schools and health centers also embraced online interactions. As a result, the biggest beneficiary of this transition was Zoom, a company that facilitates video communications. Users love it because of how simple it is to use.
Zoom has the biggest market share in video communications. It has managed to beat companies like Microsoft and Cisco. As a result, its stock has risen by more than 390% in the past year, bringing its market cap to more than $111 billion. Its revenue has also increased, reaching more than $1.36 billion in the past 12 months.
Investors hope that Zoom can leverage its scale to offer more services to customers. In other words, they see it as the next Salesforce.
However, in reality, Zoom’s growth has almost peaked, and its valuation is significantly stretched. For example, it is now worth more than IBM, a company that makes billions in profits every year. Also, I don’t see how Zoom will become a more diversified company like Salesforce.
Plug Power (PG)
Market cap: $27 billion
TTM revenue: $307 million
Plug Power is a company that develops hydrogen fuel cells for the automobile industry. Its goal is to replace traditional energy sources like oil and even batteries. Because of its promise, the stock has rocketed by more than 1,500% in the past 12 months. This makes it only $13 billion smaller than Ford.
In reality, their income statement is worse than anything. It has more than $307 million in income and more than $103 million in losses.
While the company has inked partnerships with several automakers, its industry is still young, and there are concerns about how successful it will be.
Bubble stocks are those stocks whose valuations don’t make sense when you look at the books. They are often driven by euphoria and, in most cases, tend to disappoint. To identify these companies, you should look at some of the fastest-growing sectors and identify companies whose valuations seem stretched. To be clear, this does not mean that you should short them because euphoria can go on for years.