Three Questions to Ask Before You Buy a Stock
Three Questions to Ask Before You Buy a Stock
Three Questions to Ask Before You Buy a Stock
Two weeks ago, I revealed a disturbing statistic about this market's valuations.

On May 6, 46 public companies with market capitalizations above $10 billion traded at price-to-sales (price-to-revenue) ratios above 25.

To justify that investment, a company would need to return all of its revenue to investors in the form of a dividend... for 25 years. No paid taxes (which is illegal), no payroll, no research and development, no silly shirts with the company's names on them... or stress balls.

All the revenue.

Yesterday, that figure had fallen to 28. That's how fast the valuation compression is in this market. In fact, I outlined the worst 10 stocks on the list...

I kept the original screen of stocks and their valuations two weeks ago.

I've added their prices during yesterday's intraday trading on the far right.

As you can see... all but one plunged in this market.

After the recent selloff, another string of analysts and researchers are trying to call a bottom.

Let's take a quick look at what they're saying...

And then examine three quick rules that I follow when trading overvalued tech stocks.

Today, Seeking Alpha assigned an "Editor's Pick" about a stock called Cloudflare Inc. (NET).

Let's look at three simple ways to decide if this is a buy or not.

QUESTION 1: Are the company executives buying the stock right now?

I don't need to listen to an analyst tell me if a stock is ready to rebound. I only care if the executives at the company are buying. If this stock has pulled back... and it's poised for immense growth... then why aren't they buying the stock?

A simple analysis of SEC Form 4 documents shows that only one executive has purchased shares with their own cash since the company went public. It was a director on May 9 who bought $941,607 in stock.

Since mid-2019, insiders have sold $1.6 billion in stock.

The CEO, Matthew Prince, has sold roughly $9.5 million in stock over two transactions in the last week.

No one knows the balance sheet better than the CFO, and no one knows the growth strategy better than the CEO.

So, if they're not buying the stock at the bottom... why should you?

And if they're selling the stock right now... why would you buy the stock?

QUESTION 2: What is the price-to-sales of this company?

Cloudflare's price-to-sales ratio is at 26x.

Dig deeper into the balance sheet. The operating margin is negative 18.6%. The net margin is negative 35.6%. The tangible book value is $1.48.

It's trading for $58 per share.

This stock is extremely overvalued.

QUESTION 3: Is momentum positive or negative?

You know the answer.

I am not trading or buying this stock until we have a momentum switch.

Avoid the hype.



Recap: The S&P 500 is trying to defend itself from a drop to 3,800, a place that would put the index in the bear market territory. Meanwhile, retail sellers are again dumping speculative stocks. We're going in the opposite direction of where we were earlier this week. With momentum weakening further, investors must continue to build cash positions and use tighter stops.


    • Believe it or not, U.S. economic growth is outpacing that of China for the first time since 1976. Strong consumer spending is pushing the U.S. GDP to an expected 2.8% this year. The pandemic and weak real estate development in China are likely to push China's GDP to just 2%. This is a problem for companies like Alibaba Group (BABA). I might look to short BABA into the June options expiration.

    • It's bad to worst for Ford (F). The company announced three recalls of 350,000 vehicles to address engine fire risks. This company has taken a beating in a negative momentum environment. Voz was on stage today and said that the price target to the downside is $10. I really like that price target and might look to sell call credit spreads in the coming days well out of the money.

    • Looks like we are officially in a bear market - after two years of cheerleading. The S&P 500 officially fell 20.1% from its intraday high in January. What comes next? Well, we have to be prepared for even more valuation compression, price discovery, and panic among retail and institutions. I'm going to talk to you how you can use the bear market to start building real positions for real wealth. I'm back on Monday afternoon for Midday Momentum. Check me out at 12:30 pm.


      It's a good day to revisit one of our first hotshot longshots. Shares of
 Tesla Inc. 
      (TSLA) are getting hammered again today. The stock is extremely overvalued and trading at nosebleed levels, but founder and CEO Elon Musk is now facing the fallout from a sexual harassment charge that apparently included a cash payoff for the accuser.

      The October $150 put that was initially trading in the $1.30 to $1.45 range when I discussed it. The latest trade was $2.42 today. That's a great gain.

      If you're going to get really greedy and take aim at a potential big leg down for the rest of the day, look at the June 17, 2022 $266 put trading around $1. There's a 0% chance that this finishes in-the-money, but if we see two big move downs next week and the stock falls under $600, the next move down is the $500 range. You can target a potential move similar to today, where there was a $0.50 move on the option.

      If you think Tesla isn't in trouble, Cathie Wood's
 ARK Innovation ETF 
      (ARKK) no longer carries Tesla as its top holding. That honor goes to
 Roku Inc. 
      (ROKU), a streaming platform with few barriers to entry that trades at 99 times earnings. I don't understand this ETF's strategy at all. But Tesla is out at the No. 1 spot.


      If you missed any of the live events this week, don't worry. We'll be recapping our top picks, our top trades, and much more.

    Stay liquid,