Be careful of bubble stocks and updating bubble methodology
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 (%)|
|Airbnb Inc||United States||130,635||-1.31||28.1||-29.2|
|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|
|Teladoc Health Inc||United States||41,124||-0.30||20.3||-9.9|
|Affirm Holdings Inc||United States||34,499||-0.89||39.7||-5.8|
|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|
|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|
|C3.ai Inc||United States||15,370||-0.79||69.6||-12.5|
|Bill.com 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.
Latest Market Insights
Quarterly Outlook Q3 2022: The Runaway Train
- Central banks' attempts to kill inflation is a paradigm shift, which could end in a deep recession.
Tangible assets and profitable growth are the winnersWith US equities officially in a bear market, the big question is where and when is the bottom in the current drawdown?
Understanding the lack of investment appetite among oil majorsThe everything rally seen in recent quarters has become more uneven, as its strength is driven by commodities in short supply.
The pressure is on as the wind leaves the sailsWith cryptocurrencies in sharp decline, are we entering a crypto winter or is the bear market a healthy clean-up of the crypto space?
Why the Fed can never catch up and what turns the US dollar lower?Many other central banks are set to eventually outpace the Fed in hiking rates, taking their real interest rates to levels higher than the Fed will achieve.
Bank of Japan: Swimming against the tideThe Japanese economy has gone from the age of deflation to rapidly rising prices in no time, leaving the Bank of Japan in a pickle.
Green transformation detour and bear market hibernationWith the impending risk of global econonomic derailment, we share the five things investors need to consider in this new half year.
Crisis redux for the eurozone?Whether there's going to be a recession in Europe or not, the path towards a stable economy will be agonizing.
Technical Outlook: Gold, Oil and a remarkable multi-decade perspective on EquitiesThe Nasdaq bubble pattern, USDJPY resistance, crude oil uptrend losing steam and the technical outlook for USD.
China: the train of new development paradigm left the station two years agoChina is transiting to a new development paradigm, as they are hit by deteriorating terms of trade, a slower global economy and an uncertain future while continuing attempts to contain the pandemic.