Wake-Up Calls Often Come Too Late

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Jul 17, 2012
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There have been investment bubbles for as long as there’s been trading. Tulip bulbs, the South Sea Trading company, technology shares, Internet stocks, etc. The one common denominator is the concept that with these wonderful and unique opportunities — valuation doesn’t matter.

Monday’s disaster du jour was Green Mountain Coffee Roasters (GMCR, Financial) which plunged about 9.5% to close at $17.82. This is a stock that peaked at $115.98 less than 10 months ago. At that high point it was valued at almost 50x that moment’s expected fiscal year 2012 EPS of $2.37. Of course it was only 38x fiscal year 2013 estimates of $3.05 if you believed the good times would keep on rolling.


At Monday’s close GMCR is now offered at less than 10x the newly lowered estimate of $1.80 for the fiscal year ending September 30. Fiscal year 2013 is now projected to come in at only $1.64 per share. Analysts attribute their reduced numbers to the expiration of their K-cup patent this fall which will allow for generic competition. This was certainly not an unpredictable event.

One year ago NetFlix (NFLX, Financial) was flying high at over $304 per share. That was 73x NFLX’s $4.16 in 2011 EPS. The stock cratered by almost 80% to a low of $62.40 before year-end. nflx-jan-2011-jul-16-2012-source-bigcharts.jpg

More recently, Soda Steam (SODA, Financial) fizzed upwards from under $30 to $79.72 just before plummeting back to under $30 again. At the top buyers were gladly paying about 37 times the current full year 2012 estimate of $2.17.


There’s nothing inherently bad about any of those three companies. The lesson to be learned is that paying too high a valuation leaves you at serious risk of a big decline. Momentum stocks are exciting and very seductive. They’re almost impossible to play with safely.

Look again at the three charts to see the frequent gap down openings. Stop-limit orders wouldn’t have helped you. Pure stop-sells would have gotten you out, but often at way lower than your trigger prices.

I’d advise passing on these types of stocks completely. You’ll never lose one penny by not owning a stock that goes up. It’s much more fun watching these from afar while saving your investment dollars for more predictable plays.
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