Value Traps: Why You Should Be Wary of Hot Stocks

Value traps lurk everywhere, and usually in the rubble of once-hot stocks

Readers of my column know that I am scared to death of hot stocks. You know, those are the ones that IPO and take off to the moon, or they are past the IPO and have caught the momentum traders interest.

Value Traps: Why You Should Be Wary of Hot Stocks

Of course it’s been difficult watching Netflix (NFLX) move from $60 to $700 when it generates no meaningful cash flow. That doesn’t mean I’m going to jump on the speeding train or short it, either.

There are another class of stocks that are like momentum stocks, but in reverse – value traps. That’s where hot stock fizzle out and really crater, but there exists enough interest that investors think the underlying business is really good and the former hot stocks are now value plays.

Those are tricky and you need to be careful. Let’s look at a few examples.

I think SodaStream (SODA) stream is as perfect an example of one of these hot stocks that become value traps. The stock had its IPO in 2011 at $25 per share and promptly tripled. It came back to earth very quickly, trundled along for a couple of years, then took off again to $70.

All along, I said this was a fad. People would use it a few times like they do an ice cream maker and it would gather dust. It’s way too easy to just buy soda at the store where you have unlimited flavors for pennies per ounce.

The stock hit $17 earlier this year and is now at $23. This is value trap territory, especially because now SodaStream has moved into sparkling water and away from soda. That’s going to fool a lot of people into buying when the same issues still exist.

Want to know another value trap that is still disguised as one of many hot stocks? Try Keurig Green Mountain (GMCR). The stock went nowhere for years at $1.50 (split-adjusted) then screamed to $107. Once again, it fell back to earth to $21 — and skyrocketed to $150.

Well, here we are again at $82. Suckers are thinking that this is a great value play since the stock is off 45%. No way. As I wrote recently, the hype of Keurig Kold is just hype. The chart is a classic collapsing parabola — and it still sells at 23 times earnings even though EPS will decline this year. Hello value trap!

One of the biggest hot stocks to hit the market came in 2013, in the form of The Container Store (TCS). The stock roared off its IPO and settled in at $45. Since then, it has dribbled down to $17, and people are calling it a value play.

Not me. The company’s earnings are improving, but it showed losses in 2012 and 2013, and a mere $22.6 million in net income last year. It had virtually no free cash flow in the loss years, either, and only $16 million last year.

Yet the market values the company at $802 million, or 35 times earnings. Huh?

Even if the 23% annualized expected growth was accurate, we’re talking about containers. You can buy anything this company sells at U-Line, a subsidiary of Middleby (MIDD), for less. There’s nothing special here, folks.

That’s the point of value traps. They are hot stocks that come down to earth, but at their core, they do not solve a problem. That’s the key to running a long-term business.

As of this writing, Lawrence Meyers owned shares of MIDD.

More From InvestorPlace

Article printed from InvestorPlace Media,

©2020 InvestorPlace Media, LLC