Be careful of bubble stocks and updating bubble methodology

Be careful of bubble stocks and updating bubble methodology

Equities 5 minutes to read
Peter Garnry

Head of Equity Strategy

Summary:  We are updating our methodology on the bubble stocks basket introduced in early January as too many of the stocks had very high equity valuations but because they were strong companies. In this updated 'bubble stocks' basket we now require negative earnings expectations over the next 12 months. Many of the names are still the same, but a lot new ones have entered our list. If news or data begin to disappoint against expectations and interest rates continue to climb higher on more inflation, our reflation call for this year, then the most aggressively valued stocks could come under severe pressure.

Following our introduction of the reflation theme which we expect to dominate financial markets over the next 12-18 months, we talked about bubble stocks and introduced 40 stocks that had bubble like characteristics. While all 40 stocks are aggressively valued, some of them have high valuations due to industry specific characteristics (exchange and certain software companies). We have been thinking about the bubble stocks basket since and have chosen to update the methodology. Some of the stocks are the same, but many new stocks are on the list, but we think this list is much better.

Our selection universe is still stocks listed on the exchanges in North America, Western Europe, Japan, Hong Kong, Singapore, and Australia. We filter on market cap (above $ 2bn) and require that stocks have a negative 12-month forward expected earnings per share, and that the 12-month forward EV/Sales (enterprise value to sales) ratio is above 8. Our of an initial universe of 3,776 stocks (those with market cap above $2bn), 194 stocks have negative earnings expectations and a high equity valuation on their expected revenue. Of these stocks, we select the top 40 stocks on market cap (see list below).

Name Domicile Mkt Cap (USD mn.) 12M Fwd EPS 12M Fwd EV/Sales Diff to PT (%)
Kuaishou Technology China 213,499 -0.85 16.2 -14.2
Sea Ltd Singapore 140,384 -1.26 17.3 -15.5
Airbnb Inc United States 130,635 -1.31 28.1 -29.2
NIO Inc China 94,795 -1.59 18.0 7.9
Snowflake Inc United States 84,570 -0.87 71.5 0.1
DoorDash Inc United States 67,743 -0.19 17.6 -22.9
Roku Inc United States 59,111 -0.26 23.1 -21.4
Bilibili Inc China 51,601 -4.76 18.2 -29.8
Teladoc Health Inc United States 41,124 -0.30 20.3 -9.9
XPeng Inc China 37,228 -2.41 15.0 13.9
Affirm Holdings Inc United States 34,499 -0.89 39.7 -5.8
BeiGene Ltd China 34,490 -9.78 35.8 -15.1
Unity Software Inc United States 34,299 -0.35 32.7 13.7
Plug Power Inc United States 32,156 -0.18 68.1 15.0
Seagen Inc United States 31,016 -0.11 15.9 14.0
Cloudflare Inc United States 28,050 -0.08 46.1 2.6
Splunk Inc United States 27,486 -0.21 10.8 20.7
MongoDB Inc United States 25,201 -0.98 34.1 -5.1
Exact Sciences Corp United States 24,752 -1.14 13.3 6.4
GSX Techedu Inc China 24,455 -3.34 11.8 -32.1
Farfetch Ltd United Kingdom 23,465 -0.66 10.3 -11.9
DraftKings Inc United States 23,186 -1.16 26.5 4.5
GDS Holdings Ltd China 20,998 -0.15 18.6 -1.8
10X Genomics Inc United States 20,458 -0.32 38.9 -16.1
Argenx SE Netherlands 19,397 -10.72 105.2 -12.6
Alnylam Pharmaceuticals Inc United States 19,214 -4.77 21.0 3.6
Ping An Healthcare and Technology Co Ltd China 18,942 -0.91 11.6 2.7
Innovent Biologics Inc China 18,305 -0.61 24.0 9.0
Guardant Health Inc United States 16,826 -1.50 40.5 -6.9
Zai Lab Ltd China 15,781 -2.52 87.5 -12.5
Kingsoft Cloud Holdings Ltd China 15,710 -2.56 9.6 -22.4
Yatsen Holding Ltd China 15,665 -1.17 10.7 -7.0
Oak Street Health Inc United States 15,461 -0.46 11.1 0.8 Inc United States 15,370 -0.79 69.6 -12.5 Holdings Inc United States 15,319 -0.19 57.4 -6.7
Canopy Growth Corp Canada 15,279 -0.90 24.2 -8.4
Appian Corp United States 15,229 -0.40 43.3 -52.9
Avalara Inc United States 14,770 -0.16 21.3 18.3
Elastic NV United States 14,429 -0.44 20.6 -1.0
Cree Inc United States 14,240 -0.59 21.3 -21.1
Aggregate / mean 1,565,141 30.7 -6.5

Source: Bloomberg and Saxo Grop

The red thread is that the list is dominated by US and Chinese stocks with the majority within biotechnology, software, media, and gaming. The combined market value for this group is stunningly $1.6trn but even more usual, the average price target is 6.5% below the current price which is something that rarely happens in equity markets as equity analysts typically have a positive bias in their recommendations and price targets. The average forward EV/Sales ratio is 30.7x which is around 10 times higher than the S&P 500 which is one of the most expensive equity indices in the world.

While January performance in equities was driven green transformation and biotechnology stocks, this month so far has been about e-commerce and bubble stocks with the latter segment up 11.2% month-to-date. In our team, we have tried the past couple of days to strike a tone of caution with financial conditions maxing out to the positive side and thus we think reality could begin to disappoint a bit against expectations. If interest rates continue higher, which we expect due to reflation, then the bubble stocks presented here pose a significant downside risk.



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