It's been nothing short of an outstanding 2017 for the tech sector. Up nearly 43%, tech stocks have nearly doubled the Standard & Poor's (S&P) returns of 24% this year. Given the strength of tech stocks there are no shortage of highly valued investment alternatives, but some are over the top.
Two that come to mind are data security provider Palo Alto Networks (NYSE: PANW) and seemingly everyone's favorite tweet master, Twitter (NYSE: TWTR). Palo Alto and Twitter share some common traits, including on-going losses. Another similarity is the inexplicable love both Palo Alto and Twitter continually receive from industry pundits.
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Where to begin
I'm somewhat in the minority with my dislike of Palo Alto stock. Analysts continue to marvel at Palo Alto's topline growth, and it has been impressive. Last quarter's -- Palo Alto's fiscal 2017 fourth -- $509.1 million in revenue was not only a 27% improvement, it marked the first period of $500 million plus in sales.
Largely because of total revenue growth, Palo Alto continues to garner sky-high valuations from industry pundits. Currently, Palo Alto has an average price target of nearly $162 a share, with one analyst suggesting it will hit $196 in the next 12 months.
The problem with Palo Alto, which many choose to ignore, is its unmitigated spending. Last quarter's $397.9 million in operating expenses was a 24% jump from a year ago. Make no mistake, Palo Alto's soaring overhead was hardly a one-time occurrence, it's been an on-going theme for years.
At the root of the problem are sales expenses. Palo Alto reports increased sales like clockwork, but does it ever pay for its topline growth? Last quarter Palo Alto spent nearly half its revenue -- $245.4 million -- on its sales efforts, 20% higher than a year ago. Is it any wonder that Palo Alto's loss of $0.45 a share was 20% worse than 2016, despite its swelling topline?
How wildly overvalued is Palo Alto? As measured by its price-to-book ratio (assets minus liabilities, divided by share price), Palo Alto's 17.9 is nearly two and a half times its peer average of 7.3. Based on fiscal 2018's guidance of 17% revenue growth, the love affair will likely end as Palo Alto's top line comes down to earth.
He said what?
Much like Palo Alto, it's not hard to find investors rabidly bullish on Twitter. One look at the buying frenzy that ensued following Twitter's recently announced quarter of, "record profitability" will attest to the positive sentiment. Though Twitter's already broken through the consensus average price target of $18.31 a share, one pundit suggests it's worth an eye-popping $26.
Part-time CEO Jack Dorsey also mentioned that Twitter "grew our audience." There's only one problem with the hoopla surrounding Twitter's record quarter which resulted in a nearly 20% spike in share price: It's only marginally true. Thanks to a 16% drop in operating expenses Twitter lost $0.03 a share last quarter along with a 4% drop in revenue to $590 million.
Perhaps most disconcerting was the 8% decline in ad revenue to $503 million, not to mention the 11% plunge in domestic sales, Twitter's largest market as measured by revenue. And the "record profitability" of $0.10 a share Dorsey and Twitter fans were so vocal about? That was after excluding one-time items and was a mere penny higher than last year's adjusted $0.09 a share.
As for user growth, Twitter did add 4 million monthly average users (MAUs) after factoring in its incorrect counting of third parties. But such scant MAU growth is hardly something to brag about considering Twitter's user base is so small to begin with.
For some perspective, in the last two years Twitter has added 23 million MAUs. During that same time Facebook grew its MAUs by 461 million, WhatsApp and Instagram each added 400 million, even little Snapchat nearly quadrupled Twitter's MAU additions with 87 million new users. Once investors pull back the curtain it becomes clear: Twitter, like Palo Alto, is a wildly overvalued tech stock.
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Tim Brugger has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool recommends Palo Alto Networks. The Motley Fool has a disclosure policy.