Last week, promising news was released pertaining to a potential vaccine for COVID-19, a disease that has not only resulted in the deaths of more than 1.3 million people worldwide but has also altered conventional means of living in profound ways. In a statement released on the morning of Nov. 9, American pharmaceutical company Pfizer Inc. reported optimistic findings regarding its m-RNA-based vaccine candidate for COVID-19. In a clinical trial consisting of 43,538 participants, the vaccine candidate was found to be “more than 90% effective in preventing COVID-19 in participants without evidence of prior SARS-CoV-2 infection in the first interim efficacy analysis,” according to the company. While the news prompted most equity indices to rise considerably, “stay-at-home” stocks were crushed by the development. The heavy selling off of such high-flying growth stocks provided further evidence of the inherent risks associated with investing in companies that are overly dependent on distance and virtual ways of life.
While U.S. stocks are positive for the year—which in itself is an incredible feat, given the extraordinary economic consequences of COVID-19—such gains have been dwarfed by “stay-at-home” stocks. On a year-to-date basis, the Dow Jones Industrial Average (DJIA) is up just over 2%, the S&P 500 Index has appreciated around 10% and the NASDAQ Composite has soared over 30%. However, these returns are no match for the performance of companies such as Zoom (+487% YTD), Peloton (+238% YTD) and DocuSign (+171% YTD), which all provide services that are conducive to the social and economic environment that the global pandemic has produced. The popularity and success of companies like the ones just mentioned, as well as many more, have caused institutional investment firms to actually create Exchange-Traded Funds (ETFs) that contain a plethora of stocks pertaining to a lifestyle. Just one month ago, financial services company ProShares made available an ETF whose goal is to invest “in companies which may benefit from transformational changes in how we work, take care of our health, and consume and connect — changes accelerated by COVID-19.”
While “transformational” companies have benefited immensely from the COVID-19, there will come a time when life once again resembles the pre-pandemic days, and an effective vaccine is quite a powerful catalyst for achieving that return to normalcy. During the trading days following Pfizer’s press release on its COVID-19 vaccine, stay-at-home stocks plummeted. From November 6 to November 10, shares of Zoom fell by almost 25%, DocuSign by more than 14% and Peloton by about 16%, signaling that investors were not particularly comfortable with holding stock in those companies after hearing positive news from Pfizer. As the prices of companies like Zoom, Peloton, and DocuSign have surged during 2020, so have their valuations. A Price/Earnings (P/E) ratio is a financial metric that compares the price of a company’s stock relative to the amount of earnings (profit) it generates. For example, if Company A has a stock price of $10 and generates $1 in earnings per share, then the P/E ratio for Company A would be 10. The current P/E ratio of the S&P 500 Index, a common index used to measure the health of the U.S. stock market, is 36.13. To put this value into perspective, the median P/E ratio of the S&P 500 dating back to 1871 is 14.83. While the current P/E ratio of the S&P 500 is more than double its historical median, this discrepancy is not close to that of Zoom (P/E ratio of 517) and Peloton (P/E ratio of 359). DocuSign does not even have a positive P/E ratio because it does not generate a profit!
During bull markets, it can be very easy to look at rising stock prices and believe they will never decline. However, the intelligent investor stays skeptical during all market environments, especially ones that feature newly-listed companies with unjustifiable valuations experiencing unsustainable growth, as is the case with Zoom, Peloton and DocuSign. Eventually, remote learning will be a thing of the past. Eventually, gyms will open at full capacity. Eventually, meetings will return to taking place in conference rooms where physical pieces of paper are used. When such a reversion occurs, “stay-at-home” stocks will no longer be popular and overpriced. Instead, they will just be overpriced.