Since I last wrote about GoPro (here), the stock has risen 30% mainly on strong momentum and rising expectations that the holiday season will bring in record numbers. Though the remainder of 2014 is expected to be strong for GoPro, the hype around the stock has exceeded any fundamental measures and thus leading to a stretched valuation. Trading just over $63, GPRO has hit all-time highs, a level that will prove to be unsustainable.
Analyst estimates
As seen above, analysts expect 40% of revenue (and nearly two-thirds of profits) to come from the fourth quarter. With the holiday season and rumors of a new release, GoPro Hero 4 camera, sometime in the fall of 2014, the market could continue seeing GoPro post a high 30% top line growth rate.
Stretched valuation even if high growth continues
Assuming that GoPro can continue at its current growth rate of approximately 40%, investors would be paying 4.5x sales and 56x earnings for owning the stock. There are two issues with this. 40% growth is an unlikely figure to accomplish, and those valuation ratios are absurdly high. Netflix, one of the most hated stocks in the market, shares similar valuation metrics.
What can cause the correction?
Lockup period expiration
Come late December, 107,945,976 shares will become eligible for sale in the public market, of which 10,043,042 shares will be freely tradable under Rule 144 and Rule 701 and 97,911,573 shares will be held by affiliates. Twitter saw an 18% price decline on its lockup period expiration. At such stretched valuations, you can be sure that insiders will want to cash out of GoPro near the top. Therefore, the holiday season could see GoPro selling many cameras and even more shares.
Short selling pressure
Many online brokers have not been able to find available shares to short for GoPro. This has kept the short ratio in check and thus selling pressure off the stock. Once this changes, I believe we will see much greater selling pressure surrounding GoPro.
Missing high expectations
A company trading at the high multiples will have huge expectations come earnings season. If GoPro is unable to meet these (aka achieve growth rates in the high 30%), then the stock will get slammed. Analysts have already shot down the idea that GoPro will be a player in the police body camera trend that is circulating with the Ferguson unrest. The company will have to rely on international expansion to meet growth expectations.
Bottom line: High growth with higher valuation
Investors buying GoPro at these levels should be cautious as momentum and hype are the only things supporting the stock. The company could continue to see growth it has thus far, but even that is a long shot. At the end of the day, GoPro is a hardware company that is trading at a forward P/E of over 50x.
