The Hype Heist: How 3 Overvalued Stocks Are Robbing Investors Blind

Stocks to sell

Today’s market environment has led to the emergence of many overvalued stocks, with major indices reaching new highs almost weekly. In such high-spirited times, investors often ignore fundamental principles and become susceptible to hype trains that promise quick wealth from rapidly rising stock prices. The temptation is particularly strong in the current bullish market, as hype eclipses caution, leading to potential pitfalls in investing decisions.

To some extent, I understand the appeal. In a market where optimism reigns supreme, and headlines focus on “unprecedented” gains, Nvidia (NASDAQ:NVDA) comes to mind, and investors may feel compelled to chase after the next big thing. However, such enthusiasm often blinds one to the fundamental principles of investing—valuations, growth prospects, and risk management.

Sure, strictly following the basic “rules of investing” might mean missing out on some once-in-a-lifetime opportunities. However, remaining prudent and making thoughtful decisions will ultimately save you from multiple cases of major disappointment and potential losses.

In this article, I have selected three cases where investors seem to be caught up in the hype and neglect the essential fundamentals. These three overvalued stocks may face notable downside risks, potentially resulting in significant losses for investors.

All linked charts are courtesy of Koyfin.com

Overvalued Stocks: Costco Wholesale Corporation (COST)

Source: Helen89 / Shutterstock.com

The first overvalued stock that I think you should avoid at its current levels is Costco Wholesale Corporation (NASDAQ:COST). Costco has gathered immense investor favor due to its wonderful membership-based warehouse retail model and consistent growth trajectory. In fact, it has always been an overly-hyped stock with a cult-like following.

More specifically, investors have historically been drawn to Costco for several reasons. For starters, its membership-driven revenue model provides a steady cash flow, while its focus on bulk sales and efficient supply chain management leads to healthy profit margins. Also, Costco’s expansion efforts, both domestically and internationally, have always garnered enthusiastic market reception—evidenced by eager customers forming lines ahead of new store openings.

To depict Costco’s growth trajectory, the company has increased its net sales and earnings per share (EPS) at a compound annual growth rate (CAGR) of 11.3% and 14.8% over the past five years. The fact that the company continues to grow in the double digits despite being quite mature, with decades of rapid growth behind it, is quite commendable.

However, Costco’s valuation at over 50 times earnings appears exorbitant. It not only significantly exceeds its industry peers but is also objectively hard to justify, especially considering consensus estimates projecting an EPS CAGR of about 9% over the next five years.

Wingstop (WING)

Source: Shutterstock

Wingstop (NASDAQ:WING) is another Wall Street darling currently trading at an absurd valuation. The hype surrounding Wingstop stock over the past year has been unreal, with shares gaining about 125% during this period. Does Wingstop enjoy some great qualities that merit a premium valuation? Absolutely. Does this mean the stock deserves to trade at about 22 times and 125 times this year’s expected sales and EPS, respectively? No way!

Regarding why Wingstop stock likely warrants a modest premium, it’s because its growth has indeed been very strong over the years. The company has consistently reported higher same-store sales, driven by operational efficiencies, an effective digital strategy, and a strong focus on improving customer experience through technology. Along with constantly expanding its location footprint, Wingstop’s revenues and EPS have grown at a CAGR of 22.8% and 23.1% over the past decade.

These growth metrics are certainly impressive but don’t explain how Wingstop stock can support its current valuation multiples. Consensus estimates see EPS growth of 23% over the next five years, which is indeed a strong forecast, indicating sustained growth ahead. However, even this robust estimate falls short of supporting the stock’s triple-digit P/E ratio. As such, I think it is one of the most overvalued stocks right now.

E.L.F. Beauty, Inc. (ELF)

Source: Lisa Chinn / Shutterstock.com

E.L.F. Beauty (NYSE:ELF) has caught the attention of both investors and consumers. Despite operating in the fiercely competitive global cosmetics industry, dominated by giants like L’Oréal (OTCMKTS:LRLCY), E.L.F. Beauty has carved out a niche by offering high-quality, affordable cosmetics.

The company’s value proposition to compete against the well-established industry leaders centers on providing trendy beauty products at affordable prices, particularly resonating with younger demographics. E.L.F. has utilized social media and influencer marketing in a smart way to expand brand awareness and drive sales. This strategy has clearly paid off, as evidenced by an impressive compound annual growth rate (CAGR) of approximately 48% in revenues over the past three years.

The problem, however, is that with such robust growth and impressive penetration into a challenging market, E.L.F. has become an over-hyped stock. Investors have been willing to pay sky-high multiples to take part in what could be a multi-decade growth story in the cosmetics industry. Thus, I believe that ELF stock has now become rather overvalued.

In fact, demand for shares is so high that ELF stock has doubled over the past year and is currently trading at about 63 times this year’s expected EPS. While E.L.F.’s growth story could indeed play out successfully, which could justify the stock’s current valuation, there is simply little to no room for error today. The lack of a margin of safety could translate to a heavy downside should the company’s growth slow down. Thus, caution is warranted.

On the date of publication, Nikolaos Sismanis 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.

Nikolaos Sismanis is a professional research analyst with five years of experience in the field of equity research and financial modeling. Nikolaos has authored over 1,000 stock-related articles that focus on uncovering deep value opportunities, identifying growth stocks at reasonable valuations, and shining a spotlight on overlooked international equities.

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