April Fool! We’re Not Buying the Rally in These 3 Growth Stocks

Happy April Fools’ Day! It’s a day of fun and mischief, as people try to separate nonsense from reality.

The market has pleased many investors recently, steadily building momentum over the past several months. That’s produced some great returns for shareholders of companies like Nvidia (NASDAQ: NVDA), Netflix (NASDAQ: NFLX), and C3.ai (NYSE: AI), which are up significantly in recent months.

But are these rallies real? Or is Wall Street playing a trick on investors’ hearts? Three Motley Fool contributors aren’t buying the rallies on these three names. Here’s why.

This stock shows that even market leaders can become too expensive 

Will Healy (Nvidia): At first glance, a call against Nvidia may seem counterintuitive. According to Jon Peddie Research, the company holds an 88% market share in the discrete GPU market. Since GPUs play a key role in gaming, data centers, and artificial intelligence (AI), Nvidia looks like the last stock one would want to bet against.

However, Nvidia bulls might have overlooked two critical factors: growth and valuation. Since reaching an intraday low of about $108 per share on Oct. 10, the stock price has risen by more than 130% in a little more than five months.

That increase has taken its P/E ratio above 155 and its P/S ratio to 25. Such multiples did not alarm investors during the 2021 bull market. But with the 2022 bear market changing attitudes, Nvidia might be getting a little too expensive, particularly with interest rates still rising.

© YCharts NVDA

In comparison, rival Advanced Micro Devices has risen by slightly more than 65% over the same period. It sells for 109 times earnings and 6 times sales. Still, the cost of the Xilinx and Pensando acquisitions has made AMD’s P/E ratio artificially high by temporarily reducing profits. Since those purchases did not affect revenue, AMD’s P/S ratio remains a small fraction of Nvidia’s.

Moreover, Nvidia’s recent performance shows it is in the midst of a slowdown. Revenue in fiscal 2023 (which ended Jan. 29) reached $27 billion, a growth rate of just 0.2% year over year. Also, a surge in the cost of revenue and operating expenses led to a non-GAAP (generally accepted accounting principles) profit of $8.4 billion, a 26% yearly drop.

Admittedly, with Nvidia’s role in AI and anything graphics-related, the revenue and profit growth should resume in time, and the stock can still move higher long term. However, investors should question whether any stock can support a 25 P/S ratio in a rising-rate environment. Given that valuation, lower-cost AI stocks such as AMD will likely bring higher overall returns.

Is Netflix dead in the water? Its lack of revenue growth would suggest it is.

Jake Lerch (Netflix): Shares of streaming giant Netflix have rallied 34% over the last six months. However, the recent rally looks like fool’s gold to me. Here’s why.

Let’s start with the elephant in the room: the competition. The streaming wars are still raging. Netflix is going head-to-head with streaming services run by deep-pocketed tech giants like Apple, Amazon, and Alphabet. And that’s to say nothing of other — smaller — but still iconic entertainment brands like Disney, Paramount Global, and Warner Bros. Discovery, each with their own seat at the streaming wars poker table.

As the cutthroat battle for gaining — and keeping — subscribers rages on, all of these companies are burning cash to keep new content flowing onto their viewers’ screens. The tech giants are flush with cash and can afford it — but can Netflix keep up? 

The company is already loaded down with debt. And as anyone trying to secure a loan can tell you, interest rates keep going up. Netflix’s net debt (debt-cash on hand) is currently $8.3 billion. Compare that to Alphabet, whose net debt is $0, it has about $100 billion in cash available.

What’s more, with a potential writers’ strike on the horizon, Netflix’s content costs could soar. That’s assuming the writers even agree to a new contract. If they don’t, Netflix could see its original productions halted until a new agreement is signed.

But the biggest concern of all is that Netflix’s revenue growth has dried up. In its most recent quarter, the company’s quarterly revenue rose only 1.9% from the prior year — showing that the low-hanging fruit is gone. Netflix will have to fight for every subscription dollar from here on out. And for me, that means the company’s big competitive edge has faded away. 

Investors are putting this stock’s cart before its horse

Justin Pope (C3.ai): Artificial intelligence (AI) is all over the news, and investors are gobbling up shares of stocks like C3.ai, hoping to capture big returns. So far, the stock’s delivering, rising 125% since the beginning of 2023.

The software company builds AI applications for enterprises, designed for use in industries ranging from oil and gas to government and law enforcement. Its products help users quickly analyze data, identify trends, and aid decision-making.

However, investors might expect too much from the business to justify the stock’s recent rally. For example, the company is guiding for just 4% to 5% in revenue growth in 2023, a result of switching the company’s entire sales model from subscription-based billing to consumption-based. The idea is that revenue will grow faster as its software works deeper into customers’ operations. But that could take time; C3.ai has just 236 customers despite being in business since 2009, indicating a long and slow sales cycle.

The business also isn’t profitable on any level. Management targets positive operating margins by the end of its fiscal 2024 year, but that’s not including additional expenses like stock-based compensation. Add everything up, and the company’s net losses were $262 million over the past four quarters — virtually the same as its revenue.

Investors are left waiting for answers to legitimate questions like, how much will revenue growth improve over the next few years? When will the business turn a profit? The answers to these aren’t clear — that’s why it’s hard justifying such a large surge in the stock. Therefore, investors should avoid C3.ai until there are some meaty financials to back up such a rally.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Jake Lerch has positions in Alphabet, Amazon.com, Nvidia, and Walt Disney and has the following options: long September 2023 $60 calls on Advanced Micro Devices and short September 2023 $100 puts on Advanced Micro Devices. Justin Pope has no position in any of the stocks mentioned. Will Healy has positions in Advanced Micro Devices. The Motley Fool has positions in and recommends Advanced Micro Devices, Alphabet, Amazon.com, Apple, Netflix, Nvidia, Walt Disney, and Warner Bros. Discovery. The Motley Fool recommends C3.ai and recommends the following options: long January 2024 $145 calls on Walt Disney, long March 2023 $120 calls on Apple, short January 2024 $155 calls on Walt Disney, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.