I have never spent much time on momentum stocks. These stocks tend to move higher and higher with seemingly no regard for the fundamentals of the underlying business. When momentum investors lose interest and sell their stakes, there's little support in place, and these stocks can tumble swiftly lower.
Just in 2011, we've seen some of the most popular momentum stocks get crushed in a very short time. Restaurant reservations firm OpenTable (Nasdaq: OPEN) soared from $70 at the start of the year to above $170 by late April. But once signs of a slowdown emerged, the stock fell and fell until bottoming out around $30. Netflix (Nasdaq: NFLX) has quickly morphed from the company that could do no wrong into the company that could do no right, and now trades for about one-fifth of its 52-week high.
At some point, these beaten down stocks could represent real value, and intrepid investors can start to wade in. The key is to wait until all of the sellers are flushed out. This approach is especially crucial at a time known as the "December effect." Historically, any stock that has fallen sharply is a candidate for even more selling at the end of the year as investors seek to dump losers to offset their winners for capital gains tax purposes. This action is now so widely anticipated that these stocks now get sold off a month ahead of the anticipated traditional tax-loss selling period. So some of these big losers can actually start to rebound in late November and pick up a head of steam in December and beyond.
That's what I think is happening with Sodastream (Nasdaq: SODA), which makes a carbonated drink machine for individual home use. (If you're familiar with Green Mountain Coffee's (Nasdaq: GMCR) Keurig device for coffee, then you can begin to see parallels between the two stocks, in more ways than one.)
Simply put, I think the stock is slowly springing back to life after a precipitous fall.
The key in looking for value among beaten-down stocks is to assess what a new fair value for the stock should be. Even if you think it is now too cheap, you may still need to wait. Even after a 41% one-day plunge in August, SodaStream had further to fall as formerly bullish investors only slowly shook out of the stock. I think they're done, as this next chart shows.
So what happened to this highflyer? In mid-August, Sodastream met second-quarter expectations, highlighted by a roughly 40% jump in sales and profits from a year earlier. In its first few quarters as a public company (The initial public offering took place in November 2010), Sodastream established a pattern of boosting guidance for the subsequent quarters. Not this time. Failing to do so led many to believe that what was a high-growth platform might suddenly be cooling.
After all, this is a company that saw sales jump 53% in 2010 to around $160 million. Now, sales growth is unlikely to top 40% in 2011, and the growth rate could cool to 20% in 2012 to around $270 million.
The good news: that level of growth can be sustained for a while as Sodastream systems sell to more markets. For example, the company announced in October that it has begun selling its machines and syrups in Japan. The company will enter the Brazilian market in 2012. A move into India may be next, according to management. Sodastream already has a strong presence in the United States and Europe, though it aims to get even deeper retail penetration in those markets. Sodastream is already well represented at Bed, Bath & Beyond (NYSE: BBY) and Macy's (NYSE: M), but is also ramping up at Costco (Nasdaq: COST), Staples (Nasdaq: SPLS) and Best Buy (NYSE: BBY).
The market was still digesting the sobering outlook when more impressive third quarter results were released on Nov.9 earnings per share of $0.68 beat consensus forecasts by 68%. Sales rose nearly 40% from a year earlier to around $80 million. Equally important, sales from the soda makers rose a solid 54%. Growth in consumables (the syrup bottles used to make the drinks) rose a more moderate 26%, but that's precisely what you should expect in a razors/razor blades model like this. The rising installed base of carbonating machines implies rising consumable sales in 2012 and beyond.
But the timing was awful. Shares rose more than $5 the morning of the earnings release to $39, on a day that the S&P 500 plunged nearly 4%. By the end of the day, the stock was down to $36, and thanks to the ongoing market slump, shares moved back below $30 a few weeks later.
Risks to Consider: The biggest risk is competition. Investors fear a beverage giant such as Coca-Cola (NYSE: KO) will enter the market, though some may counter that Coke would help stimulate awareness of the whole category and help all vendors.
The key questions: what is an appropriate long-term growth rate, what does that EPS, and what's a suitable target for EPS? The company has penetrated just 0.5% of all U.S. households (including my own), and roughly 10 times that many buy bottled and canned carbonated water at the supermarket. Let's assume that out of the 5% of U.S. households we're talking about, 30% of them grow to realize that you no longer need to lug home heavy bottles and cans of water, freeing up kitchen shelf space in the process. That would triple Sodastream's market opportunity in the United States.for
Penetration rates in other markets are harder to come by, but it's not a stretch to assume Sodastream doubles its total market in maturing markets such as the United States and Europe and gets decent share in new markets such as Brazil and Japan. Taken together, investors may be looking at a tripling of the 2011 sales base during the next five years, equating to around $800 million.
Action to Take--> A little back-of-the-envelope math produces EPS of $5 to $6 on that sales base. (The company is expected to earn $1.16 a share in 2011 and $1.46 a share in 2012.) It's not clear that this stock ever deserved to trade at $80 as it did earlier this year, but at $30 it looks far more attractive in relation to potential earnings power. A move back to $40 in 2012 and perhaps $50 in 2013 is not unreasonable to see. The stock at $50 in 2013 equates to a high single-digit multiple on projected profits in the middle of the decade.