If you are an experienced trader you may not have to read further—you likely already know how the mo-mo game works.
If you are a relatively new trader, you probably read everything you can out there about the markets, stock-picking, and maybe jump from service to service and new system to new system. You might even get seduced by IBD’s daily list of high-growth, high-momentum, high-beta, high P/E, and highly-priced stocks, thinking for the last two years or so that these things will never go down.
As veteran traders know, the higher they soar, the harder they fall in times of market distress.
I just wanted to make this quick point quite graphically with just a few recent examples on some well-publicized high P/E stocks which have been market favorite high-fliers over the past 24 months.
For comparison purposes, keep in mind that at the market lows last week the S&P was off about 22% from 52-week highs (for arguments sake, “most” stocks have been trading around a 10-15 P/E).
The point is, as you can see below, many of those momentum stocks which were anointed with out-of-this world P/E ratios during the market’s two-year rally, and ever-higher prices, have for the most part taken it on the chin harder than the market as a whole.
|
Company |
Symbol |
52 Wk High PE |
52 Wk Low/High |
Aug-Oct Recent Low |
% Off High |
| Crocs | CROX | 27.5 | $10.20/$32.47 | $23.33 | -36% |
| Deckers | DECK | 29.0 | $43.20/$105.83 | $73.28 | -31% |
| Sodastream | SODA | 57.4 | $23.15/$79.72 | $37.94 | -65% |
| Netflix | NFLX | 77.4 | $119.65/$304.79 | $205.21 | -65% |
| Chipotle | CMG | 55.4 | $142.82/$346.78 | $279.37 | -22% |
| Panera Bread | PNRA | 31.5 | $77.41/$133.43 | $102.45 | -27% |
| Lululemon | LULU | 73.3 | $15.54/$64.49 | $46.00 | -35% |
| Green Mtn | GMCR | 93.6 | $26.14/$115.98 | $84.08 | -29% |
Now, we do not necessarily want to pick on IBD (Investor’s Business Daily), because by and large we think it is an excellent and interesting resource for investors and traders. We are just saying “beware” of their high-beta, high-momentum, high P/E stocks, which with the right entry point can make one a lot of money and with entries near market tops, can be extremely hazardous. One of our favorite examples a few years ago was Dryships (DRYS), which we got burned on ourselves. At its high DRYS was trading around $130 and today is $2.25. Its first move down was a breathtaking drop from $130 to $48, before rebounding to $115 and then pretty much straight down to the bottom (not totally certain if there were any splits in there, but do not think so). IBD also puts forward many different tips on trading “rules” and “guidelines”, which are generally very good.
One of these, the “golden rule”, is to exit a position “no matter what” if it moves 8% down versus entry point. Now, that can certainly avoid a lot of the pain indicated in the chart above, but it also raises an interesting angle in highly volatile markets when one owns a high-beta stock. In the examples above, both CMG and GMCR made their first very significant down moves in August and then went on to new 52-week highs in September. Applying the “8% sell rule” in these cases would have given one an extreme case of whipsaw.
We know from personal experience how difficult it can be to reenter a position after taking a 5-15% loss, and have ended up watching a stock we bailed recover from lows to make astronomical moves weeks, months or years later without us. We are not saying their rule is wrong and it is prudent risk management; only that each case has to be evaluated on its own merits and one should always be alert for a reentry if one believes in the stock’s fundamental story.
(Note: Speaking of P/E ratios, Barron’s had an interesting observation this weekend. On 10/3/11 the SPX was 1099. On 10/3/08 the SPX was 1099. Doug Kass argues that the big difference is the S&P P/E ratio was 15 times then and is 12 times now. The counterpoint is that the unemployment rate then was 6.1% and is now 9.1%, not to mention the current state of the housing market. We think one could also throw into the equation a comparison of the brewing credit crisis then and the brewing European debt and banking crisis now. Which side one comes out on is the big question).
Good Trading!
David W. (aka The Underground Trader)
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