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Warning: Sell This Hot 'Cloud' Stock Now

Tuesday, March 18, 2014 - 8:30am

It would be great if investing was more science than art, but unfortunately the reverse is probably true.

In reality, stock price behavior often has more to do with to publicity, psychology, and hype than facts and figures. So sometimes investors are pretty much left to guess about what a stock, industry, or the market in general might do next.

The guesswork is most nerve-racking when a stock or group of stocks is hyped so much their prices rapidly begin soaring to unexpected heights and seem like they'll never stop rising. At that point, investors have a tough decision -- sell and lock in their gains, or hold out for more profits.

It's a hard call to make. No investor wants to cash out only to find later they did so too soon and missed out some of the best growth their investment had to offer. But it's the anticipation of this sort of remorse that keeps so many investors in the game too long, setting them up for massive losses when the hype fades and the market realizes the investment is ridiculously overpriced.

I'm not just talking about the dot-com bust a decade and a half ago. Investors have been falling into this trap for centuries, and I'm concerned they could be falling into a similar one right now.

Of course, this time a different type of investment is being hyped -- the stocks of so-called cloud computing companies, which offer a network of remote servers that enable customers to store, manage and process data online and with mobile devices. Cloud services have been gaining in popularity because they can eliminate the need for companies to buy and maintain their own servers, helping to increase efficiency and reduce costs.

Now, I'm not suggesting all cloud stocks are bad investments. But because the overall industry has gotten so much publicity that some of these stocks have risen tremendously despite highly questionable fundamentals.

There's one stock in particular I want to caution investors about, a stock that has climbed more than 400% since early 2009. Yet the company hasn't even made money for three years. And that's just one red flag for this firm, Concur Technologies (Nasdaq: CNQR), a smaller but well-known provider of integrated online and mobile software designed to help companies track and manage travel and other business expenses, invoicing, and travel itineraries.

Granted, sales have been robust, expanding nearly 22% a year from $248 million in 2009 to $546 million last year. But that hasn't been translating to sustainable profits, as this table shows:

Ironically, while Concur is in the business of helping customers manage costs, the firm's main issue is that it can't seem to control its own. Indeed, total operating expenses have soared about 30% a year from $133 million in 2009 to $382 million in 2013. By far the biggest contributors to the problem are sales, general and administrative (SG&A) expenses, which more than tripled between 2009 and 2013, from $101 million to $313 million.

Out-of-control costs have significantly harmed key measures of Concur's financial performance in addition to earnings. Indeed, margins have been declining steadily for years, and cash flow has become erratic, with a tendency to shrink.

Valuations are out of kilter, too. For instance, at two and 12 times the industry averages, respectively, the stock's price-to-sales (P/S) and price-to-cash flow (P/CF) ratios are alarmingly high. Its price-to-book value (P/B) ratio isn't too far out of line, but its forward price-to-earnings (P/E) ratio is insane.

As I dug through Concur's filings and financial statements, my main question was "Does management have any sort of cost-control strategy, or will expenses keep growing a lot faster than revenue?" I strongly suspect the latter. In the firm's latest annual report, the section containing management's discussion of financial condition and results of operations clearly states costs are expected to rise further, and that bodes ill for Concur's financial condition.

As things stand, the company doesn't appear to be in immediate danger of insolvency, and management says there's sufficient liquidity for about another year. But that means it won't be terribly long before more financing will be required, and that will only place additional pressure on the company's increasingly shaky financial status.

Risks to Consider: Besides the issues I've already discussed, Concur is a smaller player going against some other much larger rivals with far greater resources. In its present state, Concur is vulnerable to succumbing to the competition in the intermediate term.

Action to Take --> Don't assume investing in Concur will pay off just because it's in cloud computing. The stock is dangerous because of eroding fundamentals and excessive valuations.

There are signs the market has begun to recognize this, including high short interest (22% of the float) and a recent decline in the stock, which has fallen 15% in the past month. What's more, insiders have dumped 90,000 shares, worth roughly $9 million, during the past six months.

Since it looks like Concur might already be in the early stages of a major sell-off, I'd consider booking any remaining gains. Prospective investors determined to be in the cloud space would probably be better off looking elsewhere. VMware (NYSE: VMW), one of the much larger and more resource-rich competitors I alluded to, might be a more reasonable alternative.

P.S. Are you terrible at knowing when to sell? You're not the only one. Fortunately, a former trust fund manager created a two-part blueprint that reveals when to sell... and when to buy. It's been 85% accurate for over four years -- and just closed out a 70% gain. Click here to access it now.

Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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