Green Mountain Coffee Roasters just showed how momentum works both ways in the stock market. Its shares are the latest to crash down from a nosebleed trading multiple, after the company grew less than analysts expected. Green Mountain joins former investor darlings Netflix and OpenTable Each traded well over 50 times estimated earnings this summer and has since lost over half its market capitalization. Fast growth can help paper over valuation or accounting worries, but in time they usually catch up.
The Nifty Fifty moniker of the 1960s didn’t refer to the trading multiples of the companies that made the list. But they followed a similar trajectory. These high-growth companies were supposedly stable and worth buying even when their valuations approached 100 times earnings. The subsequent bear market ravaged them. Technology and tastes changed, as they’re wont to do. Buyers of Xerox, Polaroid and Schlitz Brewing shares at high multiples came to regret the decision.
So-called momentum stocks will attract attention in every age. And small, growing firms sometimes turn into giants. Moreover, markets have a habit of creating their own reality for a time. If investors chase the stocks, these shares will outperform, which then reels in still more new buyers. Fundamental analysis can burn skeptics who try to fight such trends. Get the timing wrong on a short sale, and lofty valuations may shoot even higher.
Such stocks don’t often land softly, however. Green Mountain shares were trading at more than 65 times estimated earnings in September. A thorough presentation by hedge fund manager David Einhorn in October helped persuade more investors of the company’s flaws. Concerns over its valuation, patent protection, accounting and mergers had been repeatedly flagged by other short sellers. When Green Mountain’s growth disappointed on Wednesday, the groundwork had been laid for momentum to reverse.
It won’t put an end to the quest for high-performance stocks. Chipotle Mexican Grill, Salesforce.com, and Lululemon Athletica all still trade at close to 50 times estimated earnings or higher. Amazon is valued at more than 100 times. Whether it’s coffee, burritos, yoga gear or software, what goes up almost always comes down.
Follow us on Twitter: