Stocks To Sell

The Growth Stock Gut Check: 7 Stocks to Sell as Valuations Veer Into the Stratosphere

How long will the run in growth stocks continue? The Nasdaq-100 continues to make new all-time highs seemingly almost every week. Every dip, no matter how brief, is instantly bought up as traders pile in to profit from further bullish momentum.

But trees don’t grow to the sky. At some point, the rally will end. And with the Nasdaq up more than 70% from the 2022 lows, valuations are becoming increasingly untethered from these companies’ underlying fundamentals.

As metrics such as price-to-earnings (P/E) and price-to-sales (P/S) head to ever-loftier heights for leading growth stocks, traders should be taking a wary look toward the exits. At some point the momentum will reverse, and the ensuing selling could be swift. These are seven especially risky growth stocks to sell now while prices are still favorable.

Spotify (SPOT)

Spotify (NYSE:SPOT) is the worldwide leader in streaming music. While streaming audio is a highly competitive market in North America, in emerging markets such as Latin America, Spotify has taken a dominant position in music streaming.

This led many investors, myself included, to think that Spotify could exhibit monopoly-like characteristics. In turn, this would allow Spotify to raise prices, hammer out better contracts with the record labels and greatly improve profit margins.

I was a longtime investor in SPOT stock, but I sold my position and am now bearish simply because that thesis didn’t play out whatsoever.

Specifically, in 2018, Spotify generated a gross profit margin of 25.7%. In 2023, its gross profit margin fell to 25.6%. Despite adding hundreds of millions of users, investing heavily in content like podcasts and building its brand dramatically, Spotify wasn’t able to use that to improve the business’ economics whatsoever.

That is reflected on the bottom line as well. Spotify generated a net loss of $89 million in 2018. This ballooned to a loss of $580 million in 2023. The company has yet to generate a GAAP profit on a full-year basis. While Spotify stock has more than doubled over the past year, its underlying business economics are as fuzzy as ever.

Duolingo (DUOL)

Duolingo (NASDAQ:DUOL) shares sold off sharply following a recent downbeat earnings report. Despite that, however, DUOL stock is still up dramatically in the bigger picture with shares rallying approximately 150% since the start of 2023.

There’s no doubt that Duolingo has brought a fresh and innovative approach to the language-learning arena. I live abroad and have met many fellow expats that have had positive experiences with Duolingo to help jumpstart their studies. That said, a good app isn’t necessarily a great business.

The company is still trading at 12x enterprise value to sales, and shares are going for more than 100x forward earnings. That’s quite expensive, especially as AI translation apps and tools threaten to limit the total addressable market for Duolingo’s services.

Furthermore, the free version of Duolingo’s flagship application is quite powerful, making monetization a tricky challenge as many users see no reason to upgrade. Things such as English testing certifications are interesting and could work over time, but the company will need to do more to demonstrate success.

Dell Technologies (DELL)

25 years ago, Dell (NYSE:DELL) was a popular investment as it was at the forefront of major trends in consumer electronics hardware.

That’s no longer the case. In 2024, Dell is primarily known for being a staid IT vendor. Its business is consistent but rarely grows much, and Wall Street usually assigns it a low valuation.

But all Dell had to do was sprinkle in a touch of AI and the whole narrative has flipped. Now people have forgotten that Dell’s core business is a slow-moving one, as traders latch onto DELL as a hidden AI pick. DELL stock is now up 250% over the past 12 months and its valuation multiples are rising.

Make no mistake, Dell is selling some AI enabled servers and hardware. That’s certainly useful to some extent. But reselling the latest generation of hardware is a much different position within the AI space than being the innovator creating the underlying technology. Morningstar analyst William Kerwin sees more than 60% downside for DELL stock from current levels as the hype wears off, with a fair value target of just $55 compared to today’s $160 price.

Costco (COST)

Costco (NASDAQ:COST) is probably not the first name people think of as a growth stock. However, the club store operator is in the Nasdaq index, and it’s also certainly trading like a growth stock.

With shares at fresh all-time highs, Costco is now trading for more than 50 times earnings. That’s the highest valuation COST stock has achieved in decades. It’s one thing for a small start-up with a tiny revenue base to trade for 50 times earnings; it’s quite another for a dominant retailer that already has a fairly saturated store base.

Costco has grown earnings per share at an 11.8% annualized clip over the past decade. That’s impressive stuff. But is it worthy of a 50x P/E ratio? Probably not.

Particularly if the economy starts to roll over, Costco could be vulnerable to dramatic downside. If COST stock returned to a 30x P/E ratio — hardly a fire sale price — that would imply 40% downside on the stock from here. And if earnings dropped as well during a recession, losses could be even greater.

Costco is a great business. But it’s priced for perfection right now and any sort of economic or operational hiccup could be devastating.

Cava Group (CAVA)

Cava Group (NYSE:CAVA) is a recent initial public offering (IPO) that has become one of the hottest growth stocks in the restaurant space. The expectation is that Cava will become the Chipotle (NYSE:CMG) of Mediterranean food.

And at this price, it had better achieve that goal, otherwise shareholders will be left with indigestion.

Specifically, CAVA is trading at 13x revenues, 150x EBITDA, and more than 300x forward earnings. The thinking is that Cava will open far more stores around the country and grow into its valuation over time. But it’s far from assured that the same Cava menu that is so popular in major tier-1 urban areas will play as well in other parts of America.

The fast casual market dining market is far more competitive than it used to be. And inflation and economic strain are putting pressure on consumers. If Cava becomes the next Panera or Chipotle, shareholders could still make money even from today’s lofty valuation. But the more likely outcome is that Cava will see growth slow at some point — such as during a recession — and its share price will dramatically deflate.

Micron Technology (MU)

Micron Technology (NASDAQ:MU) is one of the global leaders in the memory category of semiconductor firms.

The memory market is known for its dramatic boom/bust cycle. The memory market used to be highly competitive with more than a dozen rivals. Over time this consolidated down to a few major players, and analysts hoped that memory firms could enjoy steady consistent profitability.

But rumors of the cycle’s demise were overblown. As it would turn out, as soon as computer and smartphone demand rolled over in 2023, so did Micron’s business. The company lost a prodigious sum of money in 2023.

Analysts expect the company to return to at least breakeven results this year. But times are hardly good for Micron, with shares still trading for more than 150x forward earnings. Traders have latched onto AI as a catalyst for Micron, but its AI solutions are a fractional revenue line within its larger business.

Morningstar’s William Kerwin agrees that MU stock is wildly overvalued. He believes shares are worth just $80 today, implying that the stock has 38% downside from here. Kerwin gives MU stock a 1-star rating and warns that the company has no competitive moat and faces dramatic risks from its exposure to the Chinese market.

AppLovin (APP)

AppLovin (NASDAQ:APP) is a software company which develops and operates a mobile marketing platform and ecosystem. It offers products such as AppDiscovery, MAX and SparkLabs.

AppLovin, as the name might suggest, primarily helps mobile application developers to monetize their programs, and further boost their marketing and consumer engagement efforts.

APP stock has gone on an absolute tear over the past year with the shares rising more than 230%.

Investors are pleased that AppLovin has been able to work around some of the privacy restrictions that Apple (NASDAQ:AAPL) and other operators have put in their ecosystems. AppLovin is certainly making progress as a business and its AI ad system is also sparking investor enthusiasm.

While AppLovin is enjoying a large increase in revenues in 2024, analysts believe this is a temporary development tied to solving particular pain points such as Apple’s privacy moves. Once the current revenue growth spurt ends, analysts see revenue growth dropping to just 12% for FY’ 25 and 11% for FY ’26. Traders are currently extrapolating AppLovin’s strong earnings results into the indefinite future, but APP stock could be in for a rude awakening once growth inevitably slows.

On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.

Source link

Share with your friends!

Leave a Reply

Your email address will not be published. Required fields are marked *

Sign up now for breaking stock alerts

Subscribe to our mailing list and get interesting stuff and updates to your email inbox.

Thank you for subscribing.

Something went wrong.