The party should soon be over for two ultra-popular stocks, whose shares have skyrocketed by approximately 2,000% and 2,600% since the start of 2023.
For well over a century, Wall Street has been a stomping ground for wealth creation. Although getting from Point A to Point B involves everything but a straight line, no asset class has come particularly close to matching the annualized return of stocks for more than 100 years.
While patience is often rewarded, it doesn’t stop investors from occasionally chasing after the market’s highest-flying stocks in the hope of snagging game-changing returns over a shorter time frame. Though we often think about emotion-driven investing impacting equities when the stock market’s major indexes are taking the elevator lower, we can see this fear of missing out, also known as “FOMO,” take place when select stocks are delivering jaw-dropping gains.
To preface the following discussion, calling for a top in any stock or major stock index lies somewhere between difficult and impossible. If there were a metric or correlative event that could, with 100% accuracy, guarantee directional moves in the broader market or specific stocks, everyone would be using it.
Nevertheless, certain data points and events have strongly correlated with moves higher or lower in the major stock indexes or select sectors, industries, or major companies throughout history. What follows are two of Wall Street’s highest-flying stocks that, statistically and historically speaking, are running on borrowed time before their epic bubbles burst.
The first seemingly unstoppable stock in a monumental bubble that’s eventually going to burst is artificial intelligence (AI) goliath Palantir Technologies (PLTR 1.72%), whose shares have gained more than 2,000% since the beginning of 2023.
To be upfront, just because I believe Palantir is in an epic bubble, it doesn’t mean I don’t appreciate the company. Palantir can be viewed as a fantastic business that happens to have a historically unsustainable valuation.
One of the prime reasons investors have gravitated to Palantir stock is its sustainable competitive advantage. Its AI- and machine learning-inspired operating platforms, Gotham and Foundry, lack one-for-one replacements at scale. This means Palantir doesn’t have to look over its proverbial shoulder and worry about its customers being taken away or jumping ship to a rival. This cash-flow predictability is what helped push Palantir to recurring profitability well ahead of Wall Street’s expectations.
Palantir is also generating consistent double-digit annual sales growth from Gotham, which collects and analyzes data for the U.S. government and helps with military mission planning and execution. Having the federal government as a customer ensures the bills are being paid.
While Palantir’s business is profitable and it offers a sustainable moat, there are two historical/statistical issues that can’t be overlooked or swept under the rug.
To begin with, every game-changing technology or innovation for more than 30 years has navigated its way through a bubble-bursting event early in its expansion. The simple fact that most businesses haven’t optimized their AI solutions and/or aren’t generating a positive return on their AI investments all but confirms that investors have, yet again, overestimated the early-stage utility and broad-based early adoption of a next-big-thing trend.
If there’s a bright spot for Palantir, it’s that Gotham lands multiyear government contracts and Foundry is a subscription-based, enterprise-focused service. In short, sales won’t fall off a cliff if the AI bubble bursts. However, investor sentiment would almost certainly weigh heavily on Palantir stock.
The other issue is Palantir’s valuation — specifically its price-to-sales (P/S) ratio. Megacap stocks on the leading edge of previous next-big-thing innovations peaked at P/S ratios ranging from 30 to 43. As of the closing bell on June 12, Palantir was trading at 108 times its trailing-12-month sales.
To put this into perspective, Palantir stock could trade sideways for the next five years, and its P/S ratio would still likely fall within the aforementioned range where previous bubbles popped for companies on the cutting edge of a next-big-thing investment. That’s how far above the statistical norm Palantir’s valuation currently sits, and it’s why I believe the company’s share price will inevitably tumble.
The second high-flying, widely owned stock that, based on history and statistics, is headed for disaster is Strategy (MSTR 0.65%) (the company formerly known as MicroStrategy).
Since 2023 began, shares of Strategy have skyrocketed by almost 2,600%. The tailwind has been CEO Michael Saylor going all-in on Bitcoin (BTC 0.31%), the world’s largest cryptocurrency by market cap. Saylor’s company became the first self-proclaimed “Bitcoin Treasury Company,” with the goal of acquiring and holding this digital gold perpetually.
This approach has lured investors because of Bitcoin’s perceived competitive advantages, which include being the largest and most well-known digital currency, as well as its perceived scarcity. Only 21 million tokens are slated to be mined.
Based on an 8-K filed with the Securities and Exchange Commission (SEC) on June 9, Strategy has spent approximately $40.8 billion to purchase its 582,000 Bitcoin, which works out to an average cost per token of $70,086. Put another way, Saylor’s company owns 2.77% of all Bitcoin that will be mined.
While this approach has thus far proven naysayers wrong, I believe it’s historically and statistically destined to fail.
From a historical standpoint, we’ve witnessed leverage-driven scenarios like Strategy’s Bitcoin approach play out before — and they’ve ended with tears for investors. One of the more memorable examples was that of banks securitizing loans, including subprime loans, which was one of the catalysts that led to the subprime mortgage crisis and near-financial meltdown during the Great Recession.
Though a case can be made that Strategy hasn’t gone overboard with its usage of traditional debt instruments, it is leveraging its preferred and common stock through a steady stream of issuances to fund all its Bitcoin purchases and, concurrently, prop up the spot price of the world’s leading digital currency. History tells us this isn’t sustainable.
Since it began trading in the early 2010s, Bitcoin has navigated its way through over a half-dozen declines of at least 50%. Even though its peaks have decisively surpassed its troughs, Strategy’s own SEC filings note the possibility of potentially being forced to sell its Bitcoin holdings at a disadvantageous price if it can’t meet its debt obligations. In other words, steep bear markets are a built-in norm for Bitcoin and crypto, and Saylor’s heavily levered model hasn’t been tested for such an event.
Statistically, Strategy’s valuation also fails the sniff test relative to the net asset value (NAV) of its digital holdings. The 582,000 Bitcoin it holds equate to a NAV of $60.45 billion, based on a Bitcoin price of $103,868, as of this writing in the late evening of June 12.
However, Strategy’s market cap ended June 12 at $106.1 billion. Backing out a generous valuation of $1 billion for the company’s money-losing software operations leaves a $44.65 billion premium (73.9%) to NAV. Instead of buying Bitcoin on an exchange at $103,868, investors are ponying up $180,588 to own Bitcoin via Strategy, which makes absolutely no sense and is unsustainable.
The icing on the cake is that virtually all of Bitcoin’s first-mover and competitive advantages are gone or misperceived. It failed the real-world utility test in El Salvador, isn’t the fastest or cheapest blockchain network by a long shot, and its scarcity is held in place by computer code that, technically, can be changed by developer consensus.
It wouldn’t be a surprise if the next inevitable crypto winter decimates Strategy’s highly levered and dilutive operating model.
