Many analysts are arguing that the current market is overvalued, overbought and out of reach, much like the dotcom era in the 1990’s. This might be true, it might not. What I do know is that you must avoid overvalued companies at all costs, or you could see your portfolio wiped out.
During the go-go 1990’s, investors and traders threw money at everything to see what would stick. Nobody cared about valuation, even though tit was obvious that valuations were stretched beyond reason. This was the case with Brocade Communications (BRCD).
This is why you avoid overvalued companies
Brocade was founded in 1995 in San Jose, CA and offered data and storage networking products to a “who’s who” customer list. After their initial public offering (IPO) in 1999, it was clear that the stock was over-loved and overvalued. At one point, Brocade was selling at 100x sales and had little to no earnings! Talk about a huge red flag. To put that into perspective, it would take 100 years for Brocade to fill in its valuation. (By comparison, Apple currently trades for about 11x sales.)
When the dotcom bubble burst, the stock collapsed by more than 95%. A few years ago, Brocade was sold to Broadcom Limited for a pittance of its 1999 valuation. If you had shorted the stock at the right time, you would have made a tidy profit. All the other stockholders were completely hosed.
I bring up Brocade, because a company that just issued an IPO appears to be in the same boat. Snowflake, a cloud-based data warehousing startup, went public last week with a valuation of – you guessed it – 100x sales. That is a clear sign of overvaluation. If you were excited about the IPO, take a step back. The red flag is up.
It’s a shame that this newly public company started out so high, because it cannot sustain that valuation. The major shareholders made out like bandits. But the rest of us? Wait until the stock settles down from these nosebleed levels. Maybe it’s a good one; we don’t know yet. I do know that at these prices, you’re likely to get burned.