I want to close the week with a last look at stocks that investors should avoid as the year comes to an end. No matter how exciting the story behind a stock might be, every company has a real value, and when the shares trade far in excess of that value, there is no margin of safety, and investors who insist on owning the shares are exposed to large and permanent losses of capital.
Everyone thinks they will be smart enough to get out ahead of the crowd, but most of them play the pass-the-burning-match game with the popular momentum stocks and eventually get burned.
Some companies are almost impossible to value, and their stocks do not represent business value but are merely betting slips in a popularity contest. Social media stocks are the best example of this right now. I love social media and post articles and pictures on Facebook (FB) all the time and make snarky comments on Twitter (TWTR) on a regular basis. I have no idea what they are worth as a business or how they monetize users, but I suspect the real value is a lot lower than the current valuation. Twitter has no profits right now, and Facebook trades at more than 100x earnings, as does LinkedIn (LNKD). You aren't buying a business at that level. You are just making a bet.
The same can be said for other triple-digit-multiple companies such as Netflix (NFLX) and Amazon (AMZN). They are both good companies, and they have changed the model of shopping and television watching for many, including me. However, at 313x and 1,300x times trailing earnings respectively, there is no way a rational investor can believe that he or she is paying for a business. If you are a nimble, talented trader who is front of the screen all day, and if you want to bet on no bad news or missteps knocking these stocks down by a significant percentage, be my guest, but investors who are not full-time traders should probably just avoid these high-priced issues.
Some other stocks that trade at triple-digit multiples really should be avoided, as there is no rational explanation for their valuation and no margin of safety. I am well aware that as the economy recovers there will be increased demand for building products used in construction and in infrastructure projects. However, that does not justify Vulcan Material (VMC) trading at 494x trailing earnings and 83x the always highly accurate analysts' estimates. At 1.85x book value, it's not terribly overpriced on asset value, but neither is it cheap. Aggregates, asphalt and cement is probably going to be good business over the next few years, but you are paying too much upfront for the potential in this stock right now.
Two of this year's hot IPOs have reached prices that defy explanation as well. Noodles & Co. (NDLS) may make the very best noodles in the history of the world, but the stock trades at 194x current earnings and more than 80x the estimates. Sprouts Farmers Market's (SFM) valuation makes even less sense to me, as it faces stiff entrenched competition for Whole Foods (WFM) and Fresh Markets (TFM). It is hard to even attempt to justify 165x earnings, no matter how popular organic markets might be at the moment.
Lamar Advertising (LAMR) is still trying to get a ruling that will allow it to convert to real estate investment trust status, and I wish them well in this endeavor. Merely becoming a REIT, however, is not going to make the billboard business suddenly worth 116x earnings and more than 5x book value. It's a solid company, and it dominates the industry, but this is not a high-growth business that can even begin to justify the current valuation. I cannot work any combination of numbers to justify the current price, even if Lamar becomes a REIT next year. Getting what they are hoping for could be the worst thing to happen to traders betting on the conversion being approved, as the market will likely begin to consider the real valuation of the company. That number is a lot lower than the current share price.
I have repeatedly said that I have no clue what the market will do over a given period of time. However, I can look around and determine that it is not cheap and that the broader market is not a screaming buy. It is time to practice patience and exercise prudence. Avoid those stocks that are bets rather than businesses, and keep margin of safety as your primary concern.