by Jamie Dlugosch | October 31, 2011 1:13 pm
If you are a fan of Halloween, you should love the suspense and surprises offered around every market turn this fall. Stocks have rallied furiously in October, gaining 13% as of Friday’s close and helping erase a horrible September.
This is not a normal market. Whether we are being manipulated by flash trading, short selling or some other unforeseen force, stocks are not a safe place to put your money. Public markets no longer represent the true ideal of investing in equity securities, which is intended to be for the long term. Today, the markets are more like short-term boiler rooms where stocks are flipped more than pancakes.
The goal of the investor (or really, trader) today is not to look forward to a future distribution of assets of a company after liabilities are paid, but to find a willing buyer of stock at a higher price using whatever means available. This includes concocting stories that invoke fear in the masses or vice versa.
But these stories blow up when presented with the facts of corporate operating performance — given to us in the form of quarterly earnings reports. For a brief moment of time after earnings news is released, a stock will trade based on fundamentals as opposed to some other superfluous reason.
Here then are five stocks with sky-high valuations that likely will be scared straight — back to earth — when companies report earnings this week:
Vitamins and supplements are all the rage. Demand is skyrocketing, and companies like Herbalife (NYSE:HLF) that sell to this monster market are growing fast. As such, investors have poured money into these stocks hoping to cash in on the future.
During the past four quarters, Herbalife has easily bested Wall Street estimates, and expectations for the quarter ending Sept. 30 have grown. Wall Street expects the company to make 76 cents per share, as opposed a 69-cent-per-share estimate 90 days ago. For the full year, Herbalife is expected to make $3.08 per share. In 2012, Wall Street is looking for a jump in profits of 16% to $3.57 per share. At current prices, shares trade for 20 times current-year estimated earnings.
It will take a strong report after the bell Monday to keep HLF stock at such levels.
Sirius XM Radio (NASDAQ:SIRI) is vulnerable to a significant pullback thanks to a struggling consumer looking to save money any way possible. The growth prospects for satellite radio simply are not what they once were for this formerly promising company. Still, the $7 billion market-cap company clearly has believers.
Sirius is perilously close to the break-even mark. For the current quarter, Wall Street expects the company to make a penny per share. For the full year, the estimate is for Sirius to make six cents per share, growing 30% to eight cents per share in 2012. The stock currently trades for 30 times estimated earnings.
That is a rich price considering the tenuous position of the company. Competitive threats are very real. At the same time, a previously announced effort to raise prices might backfire on the company — similar to what recently transpired with Netflix (NASDAQ:NFLX).
One slip-up by the company, and shares could tumble. Move away from this emotional stock before the earnings hit the fan before the bell Tuesday.
Companies with products loved by the masses often become cult stocks and trade for reasons that have nothing to do with valuation. The Boston Beer Co. (NYSE:SAM), maker of the Samuel Adams line of beers, is one such cult stock. Despite multiple quarters of earnings disappointments, this stock maintains a hefty valuation. At some point, the bubble will burst.
Perhaps the piercing comes with Sept. 30 operating results to be released after the market closes Tuesday. Wall Street is looking for the company to make $1.10 per share in the period — eight cents per share lower than estimated 90 days ago. For the full year, Boston Beer is expected to make $3.36 per share. In 2012, profits are estimated to jump by 17% to $3.93 per share. Thanks to the cult following of SAM stock, investors must pay 26 times current-year estimated earnings.
Given the poor performance during the past three quarters, I would be worried about owning Boston Beer stock at such levels prior to earnings being released. SAM shares could drop 10% or more on a bad report.
Social networking is all the rage. The much-anticipated initial public offering of Groupon will be a testament to the power of momentum investing. A story with the thinnest of plausibility has managed to capture the imagination (read: trapped the suckers) of the market.
For a glimpse into what the future holds, look at the action in OpenTable (NASDAQ:OPEN). Shares have been on a one-way trip down since peaking in May. Despite taking a haircut of almost 60% since then, OPEN stock still is expensive.
OpenTable has managed to exceed Wall Street estimates in the past four quarters, but clearly not by a wide enough margin to support the share price. Wall Street has the company making 30 cents per share for the period ending Sept. 30. That number has held steady during the past 90 days. For the full year, Wall Street is looking for EPS of $1.25, growing 35% to $1.69 in 2012. At current prices, shares of OpenTable trade for 36 times earnings.
While growth expectations are strong today, competition likely will keep pressure on the stock. The only thing that can keep the train moving forward is a blowout earnings report after the bell Tuesday. If not, look for OPEN stock to continue its descent. Another 10% to 20% discount in share price is plausible.
I always get nervous when a company in an industry performs significantly differently than its peers. In the grocery business, Whole Foods Market (NASDAQ:WFM) is doing just that. In a business known for very thin margins, Whole Foods has defied gravity by making and growing profits at a significant rate.
Whole Foods has exceeded Wall Street profit estimates during the past four quarters. For the period ending Sept. 30, Wall Street is looking for a profit of 41 cents per share. That number has held steady during the past 90 days. For the full year, the average Wall Street estimate is $1.93, growing 17% to $2.26 per share in 2012. At current prices, Whole Foods trades for 38 times current-year estimated earnings.
That is a steep price considering growth at such a level in a challenging industry is likely to hit a ceiling at some point in the near future. Given recent gains, it would seem prudent to begin exiting WFM stock before cracks appear. A weak earnings report after the bell Wednesday will send this stock tumbling.
As of this writing, Jamie Dlugosch did not own a position in any of the aforementioned stocks.
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