Popular stocks are often well known for a reason. Unfortunately, their popularity can result in big pricing premiums, which means the more popular a stock gets, the harder it is for investors to make money.
The following two companies are some of the largest in Canada, sporting multi-billion dollar market caps. Looking at their valuations, it may prove tough to turn a profit by owning either stock. If you own these companies or their competitors, pay close attention.
Great to good
Shopify Inc (TSX:SHOP)(NYSE:SHOP) is a great company, period. In 2015, its market cap was under $5 billion. Today, it’s valued at more than $50 billion and operates the highest-ranked e-commerce platform in the world.
Shopify has taken market share nearly every quarter, solidifying its digital dominance. Over the past few years, annual revenue growth has averaged above 60% — there’s seemingly nothing the company cannot achieve.
Here’s the problem: eventually, every great company transitions to a good company. That is, the business still does very well, but simply not as well as the past.
The law of large numbers is partially to blame, as it’s harder to double in size as a $50 billion company than as a $5 billion company.
The other factor is competition. If a business is making outsized profits for years at a time, it’s a virtual certainty that deep-pocketed competitors will arrive.
That’s exactly what’s happening with Shopify. This year, Square, Microsoft, and Facebook all signaled their intent to compete directly with Shopify. In total, these firms are worth trillions more than Shopify and have decades more in experience.
It’s very difficult to imagine how any one of these competitors won’t put enormous pressure on Shopify’s momentum. Shopify will still be a good company to bet on, but it’s likely not worth the astronomic price of 27 times forward sales.
A losing bet
Some stocks are overvalued for decades at a time. Canadian Natural Resources Ltd. (TSX:CNQ)(NYSE:CNQ) is one of those stocks. Since 2005, shareholders have experienced a total return of roughly 0%.
Time and time again investors are convinced to trust the company with their money. Most often, the pitch is that a turnaround is just around the corner. Here’s the thing: it’s not.
That’s because oil sands stocks like Canadian Natural will likely never return a reasonable profit to shareholders. Regulatory risks are a constant threat. For example, up to 20% of oil sands production may be instantly uneconomical by 2020.
An even bigger problem is the structurally higher cost of production. Oil sands production needs additional refining versus higher-quality oil. That results in higher costs, forcing oil sands companies to sell their output at a discount.
Jeremy Grantham—co-founder of legendary investment firm Grantham, Mayo, Van Otterloo—said back in 2013, “Tar sands will end up as a stranded asset in the next decade or two.” So far, he’s been exactly right.
Nearly every oil sands company has had trouble justifying why its assets should continue to operate. Many haven’t recouped their original cost to build.
Canadian Natural isn’t expensive on most traditional valuation metrics, but based on its long-term viability, nearly any price is too high to pay.
