Momentum stocks are fun to own when they are going up. Not so much on the way down. Imagine those poor investors that bought a stock like Netflix (NASDAQ:NFLX) when it peaked above $300 per share. At about $80 per share now, NFLX is a shell of its former self.
Perhaps Netflix never was what some thought it might be: the king of the media content delivery hill. It turns out there are plenty of threats to the business that put Netflix’s future very much in question. Momentum investors don’t like questions. They expect fervent belief without doubt.
In some ways, momentum stocks are like cults (think Jim Jones). When things are going well, there are plenty of investors willing to drink the Kool-Aid.
Some say stocks like Apple (NASDAQ:AAPL) or Google (NASDAQ:GOOG) are cult stocks. They are not. While fanatics love both companies and their products, the market for both of these companies is perfectly rational. Pricing on a fundamental basis hardly resembles a crazy momentum stock.
Ultimately, the key to playing the momentum game is to keep a firm grip on reality by monitoring valuation from a fundamental perspective. It is OK to ride the wave of unfettered enthusiasm for the prospects of a momentum stock. The trick is to understand how fragile that momentum might be.
There appears to be a shift taking place in the market with respect to momentum stocks. You better be able to show investors the goods, or you will be punished. Here are three momentum stocks that still are flying high (and where they might be headed):
Chipotle Mexican Grill
This fast-food spinoff from McDonald’s (NYSE:MCD) continues to impress. Chipotle Mexican Grill (NYSE:CMG) stock has been on a steady path higher since shares went public in 2006. Gains in the stock have been fueled by strong earnings growth.
The company reported earnings results last week that beat Wall Street expectations. Chipotle made $1.90 per share in the quarter ending Sept. 30. The average Wall Street estimate was $1.85 per share. The strong numbers were needed to support what has been a rip-roaring stock in 2011. CMG shares are up 55% so far this year. For the full year, Wall Street expects the company to make $6.82 per share. That number jumps 26% to $8.60 per share in 2012. At current prices, Chipotle trades for 49 times current earnings.
However, because the stock is so highly valued already, earnings beats are critical for Chipotle. There is simply little room for error. One misstep, and CMG could crumble.