Start the conversation
Big tech has been a big winner in the stock market for several years in a row, and as a sector, it's been resilient even in the face of changing market conditions brought on by the pandemic. NO doubt, companies offering online technologies and services, especially the big names like Alphabet Inc. (NASDAQ: GOOGL), experienced record growth in 2020 and 2021.
But the party has to end sometime, and there's always a moment when the proverbial bill comes due. For quite a few tech names, we're about there. With inflation looming large and the U.S. Federal Reserve set to raise interest rates, growth is going to slow down across the board. That's a problem, because a lot of these firms tend to draw high valuation based on growth potential even if their profitability and fundamentals are middling.
Today I'm looking at three stocks that represent the extremes of this trend - they all have skyrocketing price-to-sales ratios. Not a single one of these companies is set to meet growth projections for the coming year, and, in fact, a lot of these are looking at a big crash.
If you've got these in your portfolio, now's the time to take profits and get out...
"This Is a Dog with Fleas"
First on the list is Datadog Inc. (NASDAQ: DDOG), which provides monitoring services for cloud applications, allowing a client business to observe and track a wide variety of information in its databases and servers, as well as perform complex data analysis.
A lot of its high valuation has been driven by rock solid fundamentals - over 70% year-over-year revenue growth, for one... but that was in an environment where interest rates were near zero. Its stock has yet to make profit, and it's trading at a whopping 51 P/S, which presents a scary proposition to investors who are prioritizing earnings and dividends as the Fed tightens its belt. Even if Datadog keeps along a steady pattern of growth, it will be vulnerable to more drawdowns if things stay tight.
As of last week, it was down about 17% from its lifetime high, and I think there's a long way to fall yet. Unless you're into Datadog for the very long term, you should sell as soon as possible.
Castles in the Air
Cloudflare Inc. (NYSE: NET) is in a similar position. It's a one-stop shop for web infrastructure and cybersecurity, offering a content delivery system that optimizes media delivery for end users, domain name redirection and proxy services, and vital protection from distributed denial-of-service (DDoS) attacks.
So you'd expect that it would be gobbling up clients left and right, and you wouldn't be wrong. It's posted over 50% year-over-year growth for five quarters in a row, and the cybersecurity market is continually expanding. Long-term prospects look good - or looked good.
But things look much less certain with more expensive money on the horizon. Cloudflare's still got a large debt load, and it borrows continuously to power its future growth. GAAP net loss from Q1 to Q3 2021 was over double compared to the prior year. If it has to pull back on that borrowing, it's going to slow the company down. Analysts are already projecting a sharp decrease in revenue growth for FY2022, down to 37%.
With a current P/S around 51, you can expect the stock to tumble until things average out.
Trade Out of This One ASAP
Last on our list is Trade Desk Inc. (NASDAQ: TTD), which has a slightly lower P/S than the other two companies I mentioned, around 35 as of last week. The Trade Desk is a digital advertising company with a global reach, offering clients a software platform that allows for the coordination and implementation of data-driven ad campaigns with precise targeting.
Given how much advertising is moving into digital channels from print, and how much more time people are spending online, they've seen a huge boom in growth since their founding in 2009. Their stock went up 3,000% in the past five years. And unlike the other two companies I mentioned, they're actually turning some profit - $59 million in net income as of their Q3 report.
So, what's the issue? Mostly that they're very likely to see a dip in the near future, powered by the same factors I've mentioned above, as wary investors force prices to stabilize at the lower end of price-to-sales and price-to-earnings averages. That trend will continue as long as inflation remains a problem, which it's likely to do for at least the next year. They won't get hit as hard as the other two, but if you've been in this stock a while, it's an ideal time to take the money and run.
I'm looking at stocks to buy, sell, short, and trade at the start of virtually every single trading day on Money Morning LIVE. I believe we're running one of the market's best model portfolios right now, and MML viewers get free access to it. Most of our livestreams are absolutely free to watch, and you can chat with us in real time, too. You can click right here to sign up for automatic Money Morning LIVE updates so you never miss a session.
About the Author
Garrett Baldwin is a globally recognized research economist, financial writer, consultant, and political risk analyst with decades of trading experience and degrees in economics, cybersecurity, and business from Johns Hopkins, Purdue, Indiana University, and Northwestern.