Money

Eventually Valuation Always Matters

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For months, I’ve been warning about a crash in stocks with high price-to-sales valuations.

Yet I’m aghast at how swiftly and severely the crash has happened.

Chart: The Epic Demise of High Price-to-Sales Stocks

The shares prices of these companies have experienced a 1929-grade market rout.

Over the past couple of years, I repeatedly mentioned my concern about specific stocks like Shopify (NYSE: SHOP), Teladoc Health (NYSE: TDOC) and Zoom Video Communications (Nasdaq: ZM).

I said that almost all stocks with dangerously high price-to-sales valuations were a terrible place to have your money.

Sure enough, these companies have lost 75% to 90% of their market valuation in just months.

So many inexperienced investors have lost money on these stocks.

Along the way, they’ve learned the vital lesson that eventually valuation matters.

Good Business Hasn’t Helped Shopify

Shopify is now down almost 80% from its all-time high.

When I cautioned against owning shares of Shopify, I specifically said that it was a great company but that its trading valuation made it a bad investment.

Given that Shopify’s share price has fallen almost 80% this year, you must be thinking that the company had a terrible year. But that’s not the case.

Throughout the full year of 2021, Shopify grew revenue to $4.6 billion from $3 billion in 2020 – an outstanding 57% increase.

Even better, Shopify’s operating income TRIPLED, from $90 million in 2020 to $270 million in 2021.

Revenue grew by 57% and operating income tripled… yet the stock market takes Shopify’s stock DOWN by 80%?

No, the problem isn’t that this business is struggling – it’s that the market has simply revalued this business.

Going into 2022, Shopify’s valuation touched 60 times sales.

That was ludicrously high. Eventually that valuation had to pop, and it did.

The market has now taken Shopify’s price-to-sales ratio from 60 all the way down to 12.

Chart: Shopify Price-to-Sales Ratio

This is the problem with owning incredibly expensive stocks.

Stocks teetering on extreme valuations can fall so much further than value stocks.

Even now, I’m unconvinced that Shopify, at 12 times revenue, is at a valuation worthy of my investment dollars.

Regardless, a lot of great companies have plunged from extreme valuations into value range.

I love growth companies, so seeing their valuations swoon into “buy” territory is exciting.

Call me crazy, but I hope we can have another couple of months of difficult markets for great growth companies. That way, the growth stocks will fall to complete no-brainer valuations at which we can buy them.

Because we pay attention to valuations here at Wealthy Retirement, we avoided the collapse of these overpriced stocks.

Now we watch and wait before we move in and take advantage of these stocks’ eventual rebound…

Good investing,

Jody

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