June 13, 2024

The Art of Investment

Mastering the Stock Market Strategies

Growth Stocks to Avoid Like the Plague: 3 Overpriced Picks Primed to Plummet

4 min read

Companies with potential but have valuations that ran ahead of earnings visibility

Growth stocks can be millionaire-makers and the same ideas can be destroyers of wealth. The difference between wealth creation and erosion is the timing of exposure.

During the pandemic and the subsequent rally for growth stocks, Sea Limited (NYSE:SE) stock traded at highs that was close to $400. It was among the overpriced growth stocks that plunged as markets readjusted growth expectations in a post-pandemic world.

This is just one example to back my view of being cautious while considering exposure to growth stocks that have already skyrocketed. It’s the fear of missing out that translates into buying stocks that are trading at stretched valuations.

There has been ample price-action in growth stocks in the last few quarters. The focus of this column is on ideas that have trended higher and look expensive. These stocks can be avoided at current levels and considered for fresh exposure after a meaningful correction.

CrowdStrike Holdings (CRWD)

Person holding smartphone with logo of US software company CrowdStrike Holdings Inc. (CRWD) on screen in front of website. Focus on phone display. Unmodified photo.

Source: T. Schneider / Shutterstock.com

There is no doubt on the point that CrowdStrike Holdings (NASDAQ:CRWD) is a quality name to consider in the cybersecurity business. The company provides cloud-delivered protection of endpoints, cloud workloads, identity and data.

However, CRWD stock has surged by 100% in the last 12 months and valuations are stretched. Currently, CRWD stock trades at a forward price-to-earnings (P/E) of 80.7. I therefore expect a meaningful downside from current levels before fresh exposure can be considered.

For the last financial year, CrowdStrike reported diluted earning per share of $3.09. For FY25, the company guided for earnings per share (EPS) of $3.87. This would imply EPS growth of 25% on a year-on-year basis. Therefore, a price-earnings-to-growth ratio of over 3 underscores my view on stretched valuations.

In terms of positives, CrowdStrike continues to deliver healthy average recurring revenue (ARR). Further, free cash flow (FCF) for FY24 was $938 million and it’s likely to be more than $1 billion for FY25. CrowdStrike therefore has high financial flexibility for platform development. Also, the total addressable market for the company is estimated at $225 billion for 2025. This provides headroom for sustained growth.

Altair Engineering (ALTR)

image of a cloud surrounded by various symbols related to internet connectivity and interaction

Source: Shutterstock

Altair Engineering (NASDAQ:ALTR) is a provider of software and cloud solutions for simulation and design, high-performance computing, data analytics, and artificial intelligence. The company is therefore in an attractive business and it’s not surprising that ALTR stock trades near 52-week highs. However, at a forward P/E of 71, the valuations look stretched and I would expect a sharp correction from current levels.

For Q1 2024, Altair Engineering reported revenue growth of 4.1% on a year-on-year basis to $172.9 million. Clearly, growth has been muted and Altair has guided for full-year revenue growth in the range of 6.4% to 8%. Given the expectations, a 20% to 30% correction seems likely from current levels.

In terms of positives, The company’s software revenue has continued to increase as a percentage of total revenue. Further, free cash flow for Q1 2024 was $70.7 million. With an annualized FCF potential of nearly $300 million, Altair has high financial flexibility for making aggressive investments in innovation-driven software solutions.

Novavax (NVAX)

Novavax (NVAX) vaccine for prevention of coronavirus, Covid-19, Sars-Cov-2 in doctors hands in rubber blue gloves

Source: Vladimka production / Shutterstock.com

Novavax (NASDAQ:NVAX) stock was trading above $300 in February 2021. The big rally was on the back of Novavax developing a vaccine against Covid-19. However, with Novavax being a laggard in the vaccine race, NVAX stock plunged and was trading below $5.

However, in the last month, NVAX stock has surged by 250%. I believe that this rally is a good opportunity to sell the stock with valuations looking overextended.

An important point to note is that the big rally has been on the back of news related to a partnership with Sanofi (NASDAQ:SNY). The two announced a co-exclusive licensing agreement for the Covid-19 vaccine. While the agreement will translate into a cash infusion for Novavax, there are two important points to note.

First, the market for Covid-19 vaccines is saturated and it remains to be seen if the long-term impact is positive on growth. Further, Novavax is still building its molecular entity pipeline. With a focus on research and development, it is likely its cash burn will continue. The big rally is therefore a good opportunity to sell.

On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.

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