trading investor fastStockbyte
The "momentum" stock bubble in the United States is about to burst.
After breathtaking gains of as much as 275 per cent over the past 12 months, trading favourites like F5 Networks , Salesforce.com , Netflix.com and Riverbed Technology have seen stock prices take a big hit this week, calling into question their meteoric rises.
These so-called "mo-mo" stocks have benefited from an enormous wave of enthusiasm since the U.S. stock market got another dose of bull-market fever in September, and had been seemingly impervious to pain.
No longer. Optimism was dented after F5 Networks missed first-quarter revenue estimates and forecast a weak second quarter. F5's stock plunged more than 21 per cent on Thursday as short-term traders hastily exited a stock they had jumped on as it rallied for months.
"F5 Networks is a perfect example of what happens to a momentum darling perceived as a hyper-growth story when the first sign of normality appears," said James Kelleher, director of research at Argus Research Co. in New York.
"Momentum investors leave en masse, and they know better than to come back in on dips; these are just further selling opportunities."
The company is a leader in the network optimization market, and has benefited from the demands to manage network bandwidth as data traffic grows sharply. Many of the top-performing companies of the past year, including competitors such as Riverbed, operate in industries expected to sport strong growth in coming years.
SIREN CALL OF NEW PRODUCTS
Since these businesses present opportunities, investors hop onto the bandwagon in the stock market.
"The common element amongst them is new products ... new products means growing sales and earnings at rates well beyond the average stock and the overall market," said Steven Wolf, managing director of investments at Source Capital Group in Westport, Connecticut.
"That gets the attention of investors, which prompts people to go in and buy, which makes them leaders."
The worry among investors is that these stocks will drop sharply as momentum traders leave and investors reappraise the value of these stocks.
Many of these stocks have high valuations. F5 has a 12-month forward price-to-earnings ratio of 35.5; Salesforce.com's is even higher, at 103. The average stock in the S&P information technology index has a P/E of about 17.1.
Renowned value investor Whitney Tilson, managing partner at T2 Partners LLC and the Tilson Mutual Funds, called the move in mo-mo stocks "mind-boggling." Tilson, in his January letter to clients, said short-selling shares in U.S. video rental firm Netflix was his "biggest loser" in 2010.
Even so, Tilson still holds bets that Netflix shares will fall as its valuation is extremely rich, he said. The stock, which closed on Thursday at $185, is down from a year high of $209.24 on Dec. 1.
Netflix, according to Tilson, is "priced for perfection, and any misstep would likely trigger a huge sell-off."
RIPE FOR A FALL
Of the top 1,000 U.S. stocks that have gained 30 per cent in the past 12 months, Salesforce.com is the most overvalued, per StarMine data. It would have to drop nearly 83 per cent to what StarMine estimates as its intrinsic value.
Intrinsic value is what StarMine believes a company's stock should trade at based on its most likely growth trajectory over the next decade or more (with steady growth assumed after that).
There are stocks outside this sector that have more than doubled in the last year that are seen as candidates for a sharp fall should they fail to meet lofty expectations.
Priceline.com, the online retailer, is up 112 per cent in the last year, and would need to lose 39 per cent to fall in line with its intrinsic value. Priceline's stock fell just 1.8 per cent on Thursday to close at $424.22.
Online video renter Netflix Inc was the top percentage gainer among S&P 500 components in 2010, surging 226.4 per cent. (It was named to the index on Dec. 17.) Since then, Netflix has extended those gains. StarMine data suggests the stock would have to lose 67 per cent in the next year to hit its intrinsic value.
"It's a great business, but the stock reflects that," said Brett Harriss, a research analyst at Gabelli & Co in Rye, New York, who covers Netflix. "From a valuation perspective, there's no longer a margin of error."
The market has been through this before: A big sell-off in cloud computing stocks sparked by Equinix on Oct. 6 was quickly seized on as a buying opportunity; the average cloud computing stock has gained 16 per cent since that day.
Still, high expectations set investors up for disappointment, and the implied growth in the stock price sets a high bar.
"What's baked into the stock? Assuming the current price is correct, how fast does the company have to grow in order to justify that price?" said Tim Gaumer, director of research of StarMine.
"The risk with these companies is that with the slightest whiff of disappointment, the stock gets crushed."