After their worst week in several years, high-flying stocks that defied gravity throughout 2013 look like they're in for more punishment. The reason: Despite the plunge, they still look overvalued.
Familiar names such as Netflix, Facebook and Tesla Motors, along with a number of biotechnology and cloud-computing stocks, have been pummeled in the last month. Some stocks are down more than 20 percent over that period, falling into their own bear market, and yet their valuations still far exceed those of the broader U.S. stock indexes. Wall Street defines a bear market as a drop of 20 percent or more from a recent peak.
Facebook Inc (FB.O), for example, has fallen nearly 22 percent from an intraday record reached less than a month ago. The stock was still up nearly 3.8 percent for the year at Friday's close. Among biotech names, Alexion Pharmaceuticals (ALXN.O) has declined 23 percent from a February 25 intraday high, and yet the stock on Friday was still up 7 percent for the year.
Facebook still traded on Friday at a price-to-sales ratio of nearly 20, making it the most expensive in the S&P 500, which has an overall price-to-sales ratio of 1.7. The other companies with expensive valuations read like a Who's Who of so-called momentum stocks, including Regeneron (REGN.O), Alexion, TripAdvisor and Vertex Pharmaceuticals (VRTX.O).
"There's value somewhere, but since these things aren't being traded off typical valuations, you can't go by those metrics, and it's more about when do you find that stability," said Mike O'Rourke, chief market strategist at JonesTrading in Stamford, Connecticut. The price-to-sales ratio is the way to value a stock by looking at its market capitalization in comparison to its sales over a 12-month period.
The declines have come at a time when investors overall are seeing a general improvement in economic figures, including Friday's nonfarm payrolls data, which showed strong job gains in March and more people moving into the labor force. On Friday, the Nasdaq lost more than 100 points even though the S&P 500 briefly touched another intraday record.
Tepid Earnings Forecast
Expectations for earnings have come down for the first quarter, but investors are hoping for an improved outlook for most of the S&P 500. That may cause the rotation away from hyper-growth to steady growth to continue. Earnings season begins next week with reports from Bed Bath & Beyond (BBBY.O), Wells Fargo & Co (WFC.N) and JPMorgan Chase & Co (JPM.N).
First-quarter S&P 500 companies' earnings are projected to have increased just 1.2 percent from a year ago, Thomson Reuters data showed. The forecast is down sharply from the start of the year, when growth was estimated at 6.5 percent.
"I'm not concerned about this spilling over to the broader market. We've been in a trading range, finding resistance at record levels, so this isn't cause for alarm," said David Joy, chief market strategist at Ameriprise Financial in Boston, where he helps oversee $703 billion in assets under management. "I think there are bargains to be found, just not in the names that are getting hit. Financials are attractive here, as are industrials. The more mature tech names, especially on the software side, look valuable."
The interest in speculative plays hasn't entirely eroded. Four different companies made their debuts on U.S. exchanges on Friday, and all four ended their first day higher, with the most notable being online food delivery service GrubHub Inc (GRUB.N), which shot up 31 percent. However, for those concerned that the selling in biotech, Internet retail and other trading-crowd favorites will spill over to the rest of the market, Friday was a bit worrisome. The S&P 500 gave up early gains to end the day down 1.25 percent.
"If the weakness here cascades into other sectors, that would indicate a fundamental shift in the market. If things keep rolling over, you might want to seek protection or examine your fundamentals," said Michael Matousek, head trader at U.S. Global Investors Inc in San Antonio, which manages about $1.3 billion.
Since stocks like Netflix carry valuations far above most of the market, some investors are reluctant to buy them now.
"For momentum stocks to work, you need people to believe they can go higher," said Kim Forrest, senior equity research analyst at Fort Pitt Capital Group in Pittsburgh. O'Rourke pointed out that while many of these stocks are actually still up for 2014 on an absolute basis, buyers this year are underwater, based on the shares' volume-weighted average price (VWAP).
The VWAP is a measure of the average cost of a stock for a particular period. Facebook, for instance, had gained 9 percent in 2014 as of Thursday's close. Going into Friday, investors who bought the stock this year were on average down 6 percent on a VWAP basis.
"They bought at the wrong time, based upon where the shares are now," he said. "This also means there is a high likelihood there will be overhead supply when the shares rally as investors seek to unwind the losing trades."
In the options market, investors used the opportunity to exercise some caution. Amazon.com (AMZN.O) attracted trading volume at more than two-and-a-half-times the recent daily average volume. The most active option contracts were put options expiring next week that protect against the stock falling below $320, suggesting some hedging against losses. Options trading volume for TripAdvisor (TRIP.O) surged to nearly three times the recent average. Put options outpaced calls, with 8,841 calls and 9,832 puts traded on Friday.