by James Brumley | May 8, 2014 10:46 am
Just considering the fact that Office Depot (ODP) shares jumped 16% on Tuesday in the wake of the company’s Q1 earnings report, it would be easy to conclude that the office supply retailer was finally back on track.
As veteran traders know all too well about wildly hot stocks, though, there’s always more to the story, and the stronger the market’s knee-jerk reaction, the stronger the reversal is once reality sets in again.
In other words, yes, ODP stock is very likely to come crashing down — and soon — following its post-earnings pop.
It isn’t just Office Depot that has taken traders for an unsustainable bullish spin lately, however. Nutrisystem (NTRI) and Zillow (Z) also soared out of control recently, and are equally vulnerable to a sizable pullback. Here’s why all three hot stocks shouldn’t be trusted to keep chugging at their current pace … or in their current bullish direction.
Kudos to Office Depot (ODP) for topping per-share income estimates for Q1. The office supply chain earned an operating profit of seven cents per share of ODP stock, versus estimates of four cents. Throw in the fact that the organization is going to close 400 stores now that the union of Office Depot and Office Max has had time to gel and its weaker units can now safely be culled, and it’s not hard to see why it was one of this week’s hot stocks.
There’s just one problem with expectations for brighter days from Office Depot from here, however — fewer and fewer consumers are stepping foot in office supply stores. And that problem is only going to get worse, for a number of reasons.
Perhaps the biggest reason is that the office space is becoming increasingly digitized. Rather than pens and paper, data and ideas are stores on tablets, laptops, and in the cloud. Office Depot certainly sells computers and tablets too. The trouble is, so do hundreds of other chains and online shopping venues like Amazon (AMZN). Worse, in the rare case where paper or office supplies are needed, Amazon has become the source of choice to meet that need, as well.
Times have changed, and that change largely made the office supply superstore obsolete, even if ODP is one of this week’s hot stocks.
Last week, Nutrisystem (NTRI) shares gained an impressive 20%, fueled by — and in front of — last quarter’s earnings report. Revenue was up 16% on a year-over-year basis, while earnings turned positive, to a profit of one cent per share of NTRI stock versus a loss of two cents in the same quarter a year ago.
It was the company’s fourth straight earnings beat. Better still, the last four quarters suggest that the company’s sales and earnings deterioration may finally be winding down, with analysts projecting growth on both fronts this year. Throw in the short interest of a little more than 20% of the float, and it’s no surprise that Nutrisystem tops the recent list of hot stocks.
So why is it not apt to remain hot? In the shadow of a very-near-term 20% gain, there’s just not much meat left on the bone to enjoy. NTRI stock isn’t a name that’s followed through on most its recent earnings-related pops, and even though the company appears to be in the midst of a true turnaround story, it’s always tough to convince new buyers to keep wading in when a stock looks this overbought.
Just as importantly, the chatter and euphoria surrounding the story stock have reached dangerous proportions. When investors and the media and analysts are all singing the same bullish song in pitch-perfect harmony, odds are good that all the would-be buyers are already in a position, with few — or none — left to continue bidding the stock up.
That said, NTRI stock would be a nice pickup were it to slide back to the $14.00-ish area.
Real estate listing and information website Zillow (Z) saw its shares soar 20% last week — hitting new record highs in the process — taking a cue from Trulia (TRLA) shares. Trulia, a competitor to Zillow, reported enormous sales growth for its previous quarter around that time, and it was widely presumed that if its peers were doing well, then Zillow must be doing well too.
And truth be told, it’s not a bad logic. What’s good for the goose is apt to be good for the gander, which is why the market made a knee-jerk decision to wade in — en masse — to both of these hot stocks. The doesn’t mean the market is right about Z stock, however. In fact, the recent bullishness may well be a setup for a sizable pullback.
As it turns out, the professionals expect Zillow to report a 62% jump in its top line when it posts first quarter results after the close on Wednesday … but the company is also expected to post a loss of eight cents per share of Z stock (versus a profit of one cent per share in the same quarter a year earlier).
Granted, Trulia shares also showed a weakening bottom line in conjunction with its huge jump in revenue, but that wasn’t the focal point on April 29th. At some point, however, investors are going to have to acknowledge the fact that the bottom lines for these hot stocks are pointed in the wrong direction, and they could be on that troubled path for a while.
Another round of earnings news may well provide a reminder that this growth has an ugly side, pulling the rug out from underneath Zillow now that there are some profits to be taken.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
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