So far in 2020, of the 11 sectors in the S&P 500, technology is the top performer. Just take a look at the Technology Select Sector SPDR ETF (XLK), which is up 30% Year-to-Date, compared to the overall  S&P 500 is only up 12%.

While much of the rally in the tech sector is justifiable due to our reliance on technology during the coronavirus pandemic, there are certain tech stocks that are currently trading at nose-bleed valuations.

Here we look at three such stocks that investors need to be cautious about, as they could decline by a significant margin if the markets undergo another correction.

A recent IPO

The first stock on the list is Snowflake (SNOW) that began trading on the NYSE in September. Snowflake had an IPO price of $123 per share and is currently trading at $276, indicating a market cap of $75.86 billion. Comparatively, its sales stood at $405 million in the last 12-months, indicating a trailing price to sales multiple of 187.

Snowflake is one of the most expensive stocks on the market and is yet to be profitable. In the quarter ended in July, Snowflake sales were up 121% at $133.1 million while its losses were $77.6 million. It ended fiscal Q2 of 2021 with sales and marketing expenses of over $90 million and we can see that the company is focusing heavily on reinvesting in growth.

Snowflake has a high net retention rate of 158%. This means existing customers are spending 58% more on the Snowflake platform compared to the prior-year period. While its growth metrics remain robust, investors should be wary of Snowflake’s sky-high valuation right now.

A 2020-star performer

The next stock that is absurdly overvalued is collaboration giant Zoom Video Communications (ZM). The videoconferencing platform has been one of the biggest winners amid COVID-19.

Zoom sales were up 88% year-over-year in fiscal 2020. In the first six months of 2021, its revenue growth accelerated to 270% as the shift to remote work was the norm rather than the exception. The company’s earnings per share soared 10x in this period contributing to the stock’s 530% returns in 2020.  In fiscal 2021, the company is forecasting sales to rise above 280% while EPS is expected to rise 7x.

Zoom stock has cooled off a bit since touching a record high of $588 in October. However, its forward price to sales ratio is still an expensive 50.8x. There is a chance that Zoom stock will move higher as COVID-19 cases continue to rise and especially if it beats Wall Street estimates in the upcoming quarters.  However, with a price-to-earnings ratio of 550, investors should proceed with caution.

The Trade Desk

The final company on the list is The Trade Desk (TTD), a stock that has tripled in 2020 and gained a staggering 2,900% since its IPO back in September 2016. In fact, shares are up 50% this month as TTD crushed Wall Street estimates in Q3.

In the third-quarter, TTD sales were up 32% year-over-year to $216 million, significantly higher than consensus estimates of $181 million. Comparatively, its adjusted earnings rose 69% year-over-year to $1.27 and 200% higher than analysts’ average estimates of $0.43.

TTD’s high operating leverage contributed to this rally as the company increased EBITDA margin to 36% in Q3, up from 29% in the prior-year period. The Trade Desk is one of the largest players in the programmatic ad space which is a rapidly expanding market making the stock another top long-term bet.

However, TTD stock has a price to sales multiple of almost 50x and warrants a pullback.

The final takeaway

These three names are high-growth stocks whose businesses will continue to expand.  However, their steep valuations make them vulnerable given the macro-economic uncertainties surrounding global markets.

Therefore, at these lofty price levels investors should proceed with caution but might want to consider adding these stocks to their portfolios on any major corrections.

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SNOW shares were trading at $275.89 per share on Tuesday morning, up $1.74 (+0.63%). Year-to-date, SNOW has gained 8.65%, versus a 14.14% rise in the benchmark S&P 500 index during the same period.

About the Author: Aditya Raghunath

Aditya Raghunath is a financial journalist who writes about business, public equities, and personal finance. His work has been published on several digital platforms in the U.S. and Canada, including The Motley Fool, Finscreener, and Market Realist. More...

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