In the trading and investing world, we have all sat in awe of the significant movements of the high growth stocks. In the past year, stocks like Wynn Resorts (WYNN), Salesforce.com (CRM), and Netflix (NFLX) have moved up in valuation with wild fervor. They have continued higher and higher and even higher. Pundits calling tops have been proven wrong again and again. Last year, we believed that Green Mountain Coffee Roasters (another of the so-called MoMo stocks) was at a top at $40 only to be proven wrong. We started to wonder…what is it about these companies that makes them continue to increase in price at such alarming rates, bucking the trends of the market and other companies.
Its all about growth. Momentum stocks move at such significant rates because the underlying company grows at such significant rates. The issue for market makers is trying to find what price these stocks are worth. Trying to find the value of these stocks is difficult because these companies are growing at inconsistently high rates.
To dig further into these companies, we looked at ten momentum stocks – Amazon (AMZN), Chipotle Mexican Grill (CMG), Green Mountain Coffee Roasters (GMCR), LinkedIn (LNKD), Lululemon (LULU), Netflix (NFLX), Priceline.com (PCLN), Salesforce.com (CRM), Sodastream (SODA), and Wynn Resorts (WYNN).
What we discovered when we investigated these companies was that they all are growing at significantly higher rates than the average of their industry. When we value companies, the key to discounting companies is looking at their growth rates and discount rates. The better the growth rate, the less the cap rate (discounting factor). The smaller the discount – the larger the valuation. Therefore, companies that are growing at faster rates get higher valuations.
Now that the lesson on discounting and valuing…let’s break into some analysis:
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Of the companies we covered, we saw that many of the companies are actually fairly valued or even undervalued at their current prices.
For each company, we looked at their growth rates compared to the other companies in their industry. Nearly every company was at the top or near the top of their industry in their two-year estimated growth levels. Companies with the most growth were given a 6% residual growth rate down to 4% for those growing at the least when compared to their industry.
The theory is that people are willing to pay more for more growth, but that theory cannot be compared from one company to another. Rather, it must be looked at inwardly among competitors in the industry.
The companies we found that lagged their current price target were Amazon (AMZN), Salesforce (CRM), and LinkedIn (LNKD). Salesforce and LinkedIn were not surprising as both are heavily overvalued with large P/E ratios that are even drastically above their industry and the market even looking at the future P/E. Amazon, however, was given a 5% growth rate with dicounted cap rate. The company, however, is pricing in well above what they can achieve. The problem for Amazon seems to be their operating margin. They have not been able to get above 5% since before the Recession. Despite significant growth, 450M+ shares outstanding coupled with a weak margin does not allow for significant valuations. Further any unexpected slowdowns would bring even lower valuations.
The companies that we found that outperformed were Netflix (NFLX), Green Mountain Coffee Roasters (GMCR), and Chipotle (CMG). For GMCR and NFLX, these companies are outgrowing their competition by leaps and bounds. For GMCR, the typical coffee company is growing at an average 6-9% rate YoY. GMCR is looking at around 64% growth for the next two years.(DISH). Chipotle is the same way in their industry. These companies were given the highest residuals because they are the highest growth levels in their industry.
The rest came in pretty fairly valued.
The dilemma, though, is that these valuations can change quickly. Any signs of more growth than expected are going to drastically increase the price targets for these stocks over the diminishes for any small blips. Large growth is expected for these companies, and until they show they do not have that significant growth level…these stocks will not slowdown. Look for much more growth to continue for these companies … and most likely these targets to disappoint.
The Oxen Group