This year will be known in history as the great tech stock rally. Technology came to the rescue when the world faced one of its biggest crises since the Great Depression. As the pandemic confined people to their homes, it was the technology that kept the economy running. Every segment of the population used video conferencing, cloud services, digital payment, e-commerce, e-learning, and other types of services. Tech stocks that catered to the stay-at-home culture delivered spectacular returns.
The technology industry still has immense growth potential. While a new company can see explosive growth, an old company that lagged can turn the tables with a new product. For those who are familiar, Advanced Micro Devices (AMD) made a comeback from near bankruptcy in 2015 to overtake chip giant Intel (INTC) in 2020 with its Ryzen processors. During this period, AMD stock surged from less than $2 to $95.
There are very few game-changers like AMD that have the potential to maintain their unprecedented growth. Most growth stocks land up to be a one-off rally followed by years of decline. The pandemic paved the way for some stocks. They gained overnight and rallied to unprecedented levels.
The next chapter in the pandemic rally
But the tables are turning as the calendar changes the year and Pfizer’s (PFE) and Moderna’s (MRNA) vaccines come to the market. These vaccines bring hope that the pandemic era will come to an end. Tech stocks saw a correction on the vaccine news. The ones that could sustain their sky-high valuations went back in the green, while others failed to recover from the vaccine news-led correction.
Next year will see the market react to vaccine uncertainties. It is still unclear if the vaccine can stop the virus spread, or if we would have to spend another year at home.
Zoom Video Communications, Inc. – (ZM), Splunk Inc. (SPLK), and Stamps.com Inc. (STMP) made new highs in the pandemic rally between April and September. But they witnessed a steep fall on November 9th, when the vaccine news was announced. To date, they haven’t recovered to their November 6th price level. This rings an alarm that the three stocks might have reached their peak and may not surge in 2021.
These three stocks are still trading at very high valuations as investors have priced in their high growth expectations. This has limited their upside potential. They might witness a slowdown in revenue growth in 2021, which could lead to more negative gains. Hence, it would be good to avoid buying these stocks next year.
Zoom Video Communications, Inc. – (ZM)
ZM needs no introduction. You or someone in your family might have used this app to attend a class, a meeting or conference, or catch up with family and friends. This nine-year-old company went public in April 2019 and rose to fame during the pandemic. Its stock rose fivefold in the pandemic.
ZM had a blockbuster year, with its revenue surging 367% year-over-year to $777 million in the third quarter of fiscal 2021. It was not just revenue, but profit also rose almost 90% to $198.4 million. The company raised its fiscal 2021 revenue forecast for the third time from $622.7 million to $2.5 billion, representing a 314% increase. Replicating this type of growth next year will be a Herculean task, especially as the economy starts to normalize.
While ZM CFO Kelly Steckelberg remained optimistic about the company’s growth, she cautioned investors that the impact of the pandemic remains unknown. Analysts are being cautious and estimate that ZM’s revenue will surge 38% next year. This growth rate doesn’t justify the stock’s 60 times sales per share valuation. If its growth rate decelerates significantly in 2021, the stock could plunge.
Hence, ZM is rated a “Sell” in our POWR Ratings. It holds an “F” in Trade Grade, a “D” for Peer Grade and Industry Rank, and a “C” for Buy & Hold Grade. It is also the #36 ranked stock in the 57-stock Technology – Services industry.
Splunk Inc. (SPLK)
SPLK is not a new name in the software industry, with 17 years in the business and eight years of trading. The stock started to rally in late 2017. This year, SPLK began transitioning from its licensing model to a subscription model by putting its on-premises data analytics and monitoring software on the cloud.
But the transition will temporarily impact its revenue, and investors know that. The multi-year term licenses have large upfront payments, whereas subscriptions have smaller annual payments. This temporary impact will fade as SPLK completes its transition by fiscal 2023. The company has also set long-term goals of increasing its annual recurring revenue (ARR) at a 40% CAGR by fiscal 2023.
SPLK was on track to meet its target, with cloud ARR surging 71% year-over-year in the third quarter of fiscal 2021. The pandemic gave a boost to its cloud business, and its stock more than doubled in the pandemic rally. But its third-quarter revenue fell 11% year-over-year to $558.6 million, below its guidance of $600 million – $630 million.
SPLK gave a $650 million to $700 million revenue guidance for the fourth quarter. It was way below the consensus forecast of $778 million. The company’s management blames the weakness on delays in some large deals, highlighting that it has not lost them to competitors. But its competitors like Datadog (DDOG) show no weakness in revenue.
JPMorgan even downgraded SPLK on the “magnitude of too many large deals slipping in the final days of October.” Analysts estimate SPLK’s revenue to fall 8% this year and surge 21% next year. The stock is trading at 11.5 times its sales per share, but the loss of large deals could see more revenue misses in 2021.
Hence, SPLK stock is rated a “Sell” in our POWR Ratings system. It holds an “F” in Trade Grade, a “D” for Peer Grade, a “B” for Industry Rank and a “C” for Buy & Hold Grade. It is also the #66 ranked stock in the 98-stock Software – Application industry.
Stamps.com Inc. (STMP)
STMP provides online shipping and mailing services. The company has been in business since 1996. The stock enjoyed a significant rally between 2011 and 2018, and all that growth vanished in just one year as its deal with the United States Postal Service was renegotiated. STMP rose to fame again in the pandemic as e-commerce picked up. Many retailers, big and small, were now shipping products.
STMP’s revenue surged 49% year-over-year in the second quarter, but this growth slowed slightly to 42% in the third quarter. Investors that had pumped money into this lesser-known stock and pushed it up 180% in the pandemic rally, have now taken caution. A few days after the company released its third-quarter earnings, the vaccine news came. Investors knew that STMP’s growth rate would decelerate as people go back to normalcy.
Even analysts expect STMP’s revenue to grow 27% this year and 5.5% next year. This decelerating growth doesn’t justify its 5 times sales per share. Hence, STMP is rated a “Sell” in our POWR Ratings. It holds “D” in Trade Grade, Peer Grade, and Buy & Hold Grade, and an “A” for Industry Rank. It is also the #27 ranked stock in the 37-stock Internet – Services industry.
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ZM shares were trading at $410.98 per share on Monday afternoon, up $4.97 (+1.22%). Year-to-date, ZM has gained 504.03%, versus a 16.02% rise in the benchmark S&P 500 index during the same period.
About the Author: Puja Tayal
Puja is a seasoned writer working with financial publishing companies like Motley Fool Canada and Market Realist. With over 13 years of experience in the field of fundamental research, she brings a blend of comprehensive, well-researched insights into her articles. More...
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