Wild trading swings in the first few months of 2021 are creating challenges for equity analysts, compelling some to quickly slap sell ratings on overvalued stocks or re-evaluate their financial modelling altogether.
This week, Bank of Montreal cannabis analyst Tamy Chen instituted sell ratings on two companies – Sundial Growers and Organigram Inc. – citing valuations that had deviated too much from fundamentals, even exceeding the high end of her valuation model.
Sundial’s stock experienced a 200-per-cent run-up in early February after Barstool Sports founder Dave Portnoy tweeted that he was “back in $SNDL cos I love the rush.” Moments later, he cashed in. “Just sold $sndl. Made a quick 50k. That’s how you do it boys,” he tweeted. As of Wednesday, Sundial’s stock hovered around the US$1.30 mark, off its February peak of US$2.95.
Despite the drop, Ms. Chen recommended that clients sell after placing a target price of US$0.40 per share on the stock. She said the company’s share price valuation still sits at 28 times her 2022 sales forecast, yet “in terms of top-line momentum, positioning in Canada’s recreational market and path to profitability, the fundamentals have not meaningfully changed.”
Indeed, the recent retail trading phenomenon has made it tricky for analysts to effectively derive their target prices and make predictions. Equity analysts base their stock price forecasts on company earnings, general news and major economic events that might affect a sector, but many volatile stocks are trading with no regard for fundamentals, making it tough to rely on traditional models.
“This trading phenomenon has certainly made our lives as analysts quite challenging, because our clients look at a stock, then look at our target price and go: ‘Wow, do you have this valuation wrong?’” said Rahul Sarugaser, a Toronto-based analyst at Raymond James who covers biotech and cannabis – sectors that have been particularly vulnerable to market volatility.
Mr. Sarugaser calls it being in an “irrational valuation environment” and says he has had to more frequently brief the sales division of the bank about whether a company’s stock still has intrinsic value.
In terms of his own modelling, Mr. Sarugaser usually factors in historical stock prices as one way to make more accurate predictions. But this year’s market turbulence was out of sync with even the historical performance of many stocks.
For example, in a Jan. 4 briefing to clients, he noted that Profound Medical – a Toronto-based biotech company that is developing a treatment for prostate cancer – has tended to see its stock price spike sharply ahead of the annual J.P. Morgan Health Care Conference and that the run-up could represent a “significant opportunity.” This year, however, it was sharply amplified and lasted much longer, followed by a massive dip five weeks later.
“What is driving a lot of the sentiment in the biotech sector is COVID-19 and people seeing the potential of companies that can deliver therapeutics or vaccines related to COVID,” he said. “But this has also spilled over into the broader biotech sector – companies that have nothing to do with COVID are also seeing these massive value inflections.”
Andrew Carter, a long-time analyst with Stifel Financial Corp., based in St. Louis, said the recent ups and downs of the stock market have made it difficult to be constructive when evaluating whether to alter a rating on a stock.
When the share price of cannabis company Cronos Group Inc. surged more than 130 per cent in the first five weeks of 2021, Mr. Carter said he made the call that downgrading the company’s rating would have been a “knee-jerk” reaction. “But don’t get me wrong – there is a fundamental valuation to everything, so you have to make the call if a rally goes on for too long,” he added.
In light of this market volatility, some analysts have also observed a higher-than-usual degree of sector rotation – the movement of money (usually by institutional clients) from stocks in one industry to another.
“We saw a lot of rotation in the first few months of the year and a lot of calls from clients asking where we see value in companies that have not participated in this broader rally,” said Suthan Sukumar, a tech sector analyst at Toronto-based investment dealer Eight Capital. He cited the example of Shopify Inc., which saw a massive increase in its stock price in the first two weeks of February.
“We saw investors trimming their positions and moving them into a less volatile name,” Mr. Sukumar said.
“With tech stocks, the elevated volatility has somewhat become a norm,” he said. “But where it gets complicated for us is a lot of these smaller names with a wider-than-ever base of retail investors.”
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