News Analysis date published New: 
Wednesday, August 1, 2012 - 08:00
New Date created: 
Wednesday, August 22, 2012 - 11:38
New Date last updated: 
Wednesday, August 1, 2012 - 08:00

Sell This Insanely Overvalued Stock Before it Crashes

Wednesday, August 01, 2012 8:00 AM

Avoiding big losses is just as important to your portfolio's performance as scoring big gains. And right now, the market is sending a signal that one of the most popular names in technology is headed for a big loss.

After bottoming out near $22 in November 2008, the stock in question is up almost 470% at its current price of $125. This kind of bullish movement would be interesting on its own, but what makes it even more so is that it comes on virtually no earnings growth. In fact, this company barely has any earnings at all, with analysts currently projecting full-year earnings of just 2 cents.

This means shares trade for about 6,250 times 2012's earnings estimate -- an absolutely staggering valuation that is more than 446 times richer than the S&P 500's forward price-to-earnings (P/E) ratio of 14. To put that into perspective, if Apple (NASDAQ: AAPL) carried the same valuation, then its share price would be trading at more than $275,000.

The company I am talking about is Salesforce.com (NYSE: CRM), a leader in customer relationship management (CRM) software with a market cap of $17 billion.

There is no question that Salesforce is a great company with excellent products, smart employees and legions of dedicated followers. But it's important to remember that there is a big difference between a great company and a great stock. And right now, based upon earnings, this stock looks like a real lemon.

The market has proven time and time again that these nosebleed valuations are unsustainable. This was on full display back in early 2000, when many technology and biotech stocks traded into the triple digits with almost no earnings. And we all know how that story ended -- with millions of investors sustaining huge losses. With Salesforce.com scheduled to report second-quarter earnings on Aug. 16, this is the perfect time to get defensive and exit this overpriced stock amid growing evidence of a slowdown in technology sales and earnings growth.

Second-quarter results from the technology sector so far have been less than stellar, with earnings growth slowing to 6.9% from 21% last year. And when you remove Apple from the group, this number drops to a negative 3.2%. This is a clear sign that tech spending has slowed.

That trend was reinforced by Intel Corp. (NASDAQ: INTC), which is viewed as a bellwether for the industry. Although the company beat the Street's expectations by 2 cents, reporting earnings of 52 cents, Intel's cautious outlook spooked analysts into lowering their full-year outlook by 10 cents to $2.40. That speaks of lower capital spending in the second half of the year, as companies choose to build their cash positions and insulate their balance sheets. So even if Salesforce pulls through with an earnings surprise, then tepid guidance could hit shares hard.

And recently lowered earnings estimates suggest that Salesforce.com will not report a great quarter. In the past 90 days, while the current-quarter estimate has jumped to 4 cents from 1 cent, the next quarter's estimate has fallen from a gain of 2 cents to a loss of 2 cents. The full-year estimate has also been reduced from 10 cents to just 2 cents. And analysts now expect 26 cents rather than 29 cents next year.

These bearish earnings revisions ahead of the company's quarterly results are a sign that the analyst community isn't expecting a blowout quarter or particularly bullish guidance. Both of those outcomes would weigh heavily on a stock trading with such an insanely high valuation.

Risks to Consider: Momentum stocks have been known to defy skeptics and trade with high valuations for long periods of time. Although I don't think that will happen with Salesforce.com, anyone selling or shorting this stock should be aware that market disconnects can exist for an extended time.

Action to Take --> Salesforce.com is one of the most overvalued stocks in the market right now. Stocks that trade at unsustainable valuations are very sensitive to earnings and guidance. A small earnings miss or disappointing guidance could have a big impact on the stock and send shares spiraling lower. Sell this stock if you own it or short the stock.

P.S. My colleague Amy Calistri is an expert at avoiding stocks headed for big losses. To date, she's had gains on 86% of her stock picks in her real-money portfolio. She's able to find a winner in nearly any market. To get the name and ticker symbol of her latest stock pick, click here.

Michael Vodicka does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of INTC in one or more of its “real money” portfolios.