The Blueprints for this Market (Part 3)

 | Apr 28, 2014 | 11:00 AM EDT
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Let's get to present day.

First, with the exception of some very-high-profile momentum names that actually have high-powered earnings growth -- namely Google (GOOG) and Facebook (FB) -- the destruction has been contained to companies that are money losers that are selling at very high enterprise-to-sales ratios. The poster boys of the era in the software portion of the market, typically software-as-a-service stocks, were trading at about an enterprise-to-sales ratio of 22, which is almost 3x the historic average for fast-growing software companies in the period from 2002 to 2011, which I describe as before the beginning of the expanding bubble. While some of these stocks have come well off their highs, they are still well in excess of that mean, with Splunk (SPLK) selling at an enterprise-to-sales ratio of 18, ServiceNow (NOW) of 17, Tableau (DATA) at 15, Workday (WDAY) at an astounding 28 and FireEye (FEYE) at a ridiculous 37 enterprise to sales ratio. To put all of this in context, (CRM) sells at a comparatively normal enterprise to sales ratio of 8.

Now we have to put these overvalued stocks into some perspective. If you add up Splunk, ServiceNow, Tableau and FireEye, you get to roughly $22 billion in market cap. That's less than Brocade at its peak. Do you really think that Brocade could have ever brought down a market? Workday, the most extreme market capitalization, is at $12 billion, the same size as CMGI. Again, that's a flea compared with the market's aircraft-carrier worth of planes.

They just happen to be very visible.

How about Netflix (NFLX) and Amazon (AMZN)? I have held for years that they are cult stocks. They are similar versions to some of the bigger-capitalization names of the 1999 to 2000 period, except we forget that stocks like Microsoft and Intel were immensely profitable at their peaks. Amazon and Netflix aren't. But Amazon was a stock that a lot of growth managers felt they had to own to beat the S&P and lots of retail investors simply loved. Still, you are talking about a $139 billion company that does make money. But many portfolio managers were in it because it was rallying and nothing more. When the momentum peaked their interest peaked and they have been liquidating ever since. A flailing $140 billion company can cause a lot of damage in its decline, as it is 10x the market cap of Splunk, Service Now, Tableau, FireEye and Workday combined. But I think that it's the retail love, coupled with the professional hate, that's causing so many problems.

What was Amazon's crime? What caused the decline? Nothing except its modus operandi went from being loved to being reviled. Until this year, portfolio managers loved its sales growth. It's incredible that this quarter, which had excellent sales growth -- don't let anyone tell you otherwise -- was suddenly scorned for its lack of profits and high spend and build-out to take advantage of the opportunities. That's precisely why you were supposed own it going into the year. In fact, before the psychology turned on Amazon during the conference call, the stock was flying high. I am sure the people at Amazon, if they cared about the stock, might have been mystified by the decline because the big turnoff was the repeated mention of "heavy" spending for China. Six months ago a company with amazing sales growth and a rapid advance into China would have been a must-own. Now it is a must-hate. The turn was breathtaking. Many analysts who held Amazon high because of that growth cut their subjective price targets instead of boosting them, which they could have easily done, and I think that's because they saw the writing on the wall, or at least on the tape, that Amazon's philosophy had gone out of fashion. The love affair with Amazon's ways was over. But, believe me, it was the analysts and their hedge fund friends who jilted Amazon and not the other way around.

But given that so many newer companies had opted for the high-growth, high-spend style of Amazon, including the offending five I have mentioned, there was a ton of negative pin action of the quarter. And there might still be.

Netflix? I refuse to even entertain the prospect of lumping Netflix in with this group. Netflix is a retail stock. It is a Tesla (TSLA). It trades on sign-ups and sign-ups were robust. Let's keep it in perspective. Netflix is a $20 billion company that has quadrupled to that level in 15 months. Frankly, if it were to come down another 100 points it would still be up huge. I think that, unlike Amazon, it is NOT an institutional name. Amazon was owned because it was going up. Once it stopped, the ardor cooled. Netflix is owned because it is liked and because the metric to beat was sign-ups. Suddenly the market wants earnings, so it isn't enough.

I suspect that if Tesla doesn't report much better sales and earnings growth when it reports in a week, this $25 billion company could be sliced and diced too. Cult stocks don't change their stripes and morph into value plays overnight. That never happens. The whole shareholder based turns over and that's not going to happen quickly.

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