After a furious two-month rally that has pushed the major indices to yearly highs, it seems to be an appropriate time to look at stocks that have been receiving perhaps too much investor affection. When the market takes a breather, these are often the first stocks to be dumped by momentum investors.
So, I ran a screen for stocks that have risen at least +40% in the last three months and sport projected 2011 price-to-earnings (P/E) multiples above 40. There are surely some high-growth names here, but there are also low-growth stocks that, at least at first glance, don't merit such a strong move.
The logical rebounders
Some of these stocks are here simply because they were likely too undervalued earlier in the summer. Back in July, I suggested that Amazon.com (Nasdaq: AMZN), trading at $120, was due for a rally and predicted that "as investors start to once again embrace the company's robust long-term outlook, shares should eventually power past the $150 mark seen earlier this spring." With shares now at $170, it's hard to find any appeal in this stock, as it now trades for 47 times next year's profits.
Now with a much loftier P/E multiple, which is nearly twice next year's sales growth forecast, it looks like too much optimism is the name of the game.
When the market gets carried away
I am among thousands of very happy Netflix (Nasdaq: NFLX) customers. The video delivery and streaming service continues to attract new subscribers at a stunning pace, and that's pushed its stock into the stratosphere, trading at more than 40 times projected 2011 profits. But I've seen this picture before. In 1999, Walmart (NYSE: WMT) sported a very rich multiple, as investors assumed that strong growth would continue forever. But growth started to decelerate and shares slowly lost that P/E premium. A decade later, shares of Walmart have gone nowhere, and still-rising sales were met with an ever-shrinking P/E. I fear a similar fate will befall Netflix.
Travelzoo's (Nasdaq: TZOO) growth spurt
This online travel site has surely posted impressive recent results. Profits for the September quarter were double the consensus forecast, as the company saw a +17% jump in revenue. Results were depressed in 2009, but demand for travel is clearly on the mend. Yet investors are clearly getting carried away, assuming that this company can grow at a very fast pace in the next few years. After all, the online travel market is largely mature, with formidable competition coming from the likes of Priceline.com (Nasdaq: PCLN) and Expedia (Nasdaq: EXPE).
Travelzoo's sales are likely to rise around +20% this year and +10% next year -- logical assumptions in light of the +10% annualized growth posted in 2007, 2008 and 2009. So why do shares trade at 40 times next year's projected profits? Because investors are still reacting to recent strong results, and momentum investors smell a winning continuing trade.
I'd hate to be around when the momentum investors take profits. We may already be there. Shares surged strongly last week and on Monday, but are starting to drift back Tuesday.
Room to run?
Not all of these strong gainers look ripe for profit-taking. For example, micro-cap Cleveland BioLabs (Nasdaq: CBLI), which has doubled in the last three months, could rise much higher if it sees strong demand for its anti-radiation treatment. The U.S. government may eventually look to stockpile the company's drug in order to treat to the effects of a potential nuclear attack, such as with a dirty bomb. As with any small biotech, this stock remains speculative, and investors should do lots of homework before jumping in.
In a similar vein, Depomed (Nasdaq: DEPO) is another promising biotech play that could easily trend much higher -- if all goes according to plan. The company's oral drug delivery platform has brought interest from a number of major large drug companies that aim to license the technology. Depomed already uses that technology in its drugs that treat diabetes and urinary tract infection, and is also testing other drugs that have large potential market sizes. The company's potential licensees are hoping to secure FDA approval in the next few quarters. Yet I repeat, this remains speculative, and investors should do lots of homework before jumping in.
Action to Take --> A strong run for a stock is not always a reason to sell. Back in the 1990s, Cisco Systems (Nasdaq: CSCO), Dell (Nasdaq: DELL) and Walmart routinely occupied the annual best-performing lists, year after year after year. But it's hard to find any stocks in this group that are on the cusp of a robust long-term rise in sales, with the possible exception of the biotechs noted above.
With the market posting a furious recent rally, a reversal may be the next move. And if that happens, these richly-priced stocks may be especially vulnerable.