Tags: DavidNFrazier | Story | Stocks | Momentum

David N. Frazier: 'Story Stocks' and Other Momentum Stocks Fall Sharply

By    |   Monday, 07 Apr 2014 11:12 AM

The Nasdaq Composite Index took a big hit Friday, falling 2.6 percent compared to the prior day’s close in response to sharp declines in "story stocks" and other momentum stocks.

Leading the decline were stocks such as athenahealth (ATHN), FireEye (FEYE), TripAdvisor (TRIP) and Tesla Motors (TSLA), which fell 11 percent, 8.2 percent, 6.1 percent and 5.8 percent, respectively, compared to their closes on the prior day.

Other high-flying momentum stocks that were responsible for Friday’s big drop in the Nasdaq were Qihoo 360 (QIHU), Palo Alto Networks (PANW), Michael Kors (KORS) and Amazon.com (AMZN), all of which declined by more than 3 percent.

Editor's Note: Free Video — ‘Rogue Calendar’ Could Turn 490% Profits

In spite of Friday’s sharp selloff in the Nasdaq, the S&P 500 Index, which is a better barometer of the overall U.S. stock market, declined by only 1.3 percent compared to the prior day’s close.

Perhaps more importantly, the S&P 500 Index closed Friday at a level that was higher than its close during the previous week, revealing that Friday’s rout in over-priced story stocks and other momentum stocks didn’t spill over in any destructive way into other sectors of the market.

Meanwhile, government agencies and private economic-research firms reported last week that the readings on several leading economic indicators rose during the most recently reported period, suggesting that U.S. stock prices, in general, will continue to trend higher during the next couple of months.

For example, the Department of Commerce announced last Tuesday that construction spending in the United States rose for the 32nd consecutive month during February, and the Institute of Supply Management reported Thursday that economic activity in the services sector of the economy rose during March.

Separately, the Department of Labor announced Friday that the number of overtime hours worked by manufacturing production workers rose sharply during March. Historically, stock prices have trended higher following increases in those leading economic indicators.

So, while last week’s substantial drop in the Nasdaq Composite Index gave the media something to talk about, my research indicates that there’s no reason to pay much attention to Friday’s sharp pullback in that technology-laden stock-market index.

Yet, Friday’s big decline in the Nasdaq Composite Index, and the stocks that were responsible for that decline, highlight the risks of investing in or speculating on the price direction of "story stocks" — in which share prices reflect the future potential earnings of their underlying companies rather than the current or likely future earnings of those companies.

"Story stocks" include companies such as Twitter (TWTR) and Tesla Motors (TSLA), which haven't yet turned a profit (and might never make a profit), as well as companies such as athenahealth (ATHN) and 3D Systems (DDD), which did earn a profit during the past few years but its stock is priced at very high levels compared to the likely future earning capacity of those companies.

I warned about the dangers of investing in those types of stocks in some articles that I wrote for Moneynews during the past few months.

For example, in an article that I wrote about Twitter on Dec. 17, I told our readers that “financial market participants appear to be substantially overvaluing TWTR ....”

I went on to say, “The fact that TWTR closed [on Dec. 16, 2013] at a price that’s equal to 23 times Wall Street analysts’ projections for the company’s revenues, and 125 times its earnings before interest, taxes, depreciation and amortization (Ebitda), for the year 2015 seems to support that claim.”

I added, “I’m concerned about the company’s ability to earn a profit ... [and] ... I urge any of you who are following Twitter to hold off on allocating any of your money to TWTR until the company gives some type of assurance that it will earn a profit.”

In an article that I wrote on 3D Systems (DDD) on Jan. 30, I said, “my research indicates that 3D Systems will not be able to grow its profits at a rate that would be fast enough to justify the current price of the company’s stock.”

I added, “With 3D Systems’ stock closing at a price-to-earnings (P/E) multiple of approximately 175 on Jan. 30, and my research indicating that the company will be able to grow its earnings per share at rate of no higher than 50 percent over the next three years, my experience suggests that financial market participants are still overvaluing DDD substantially. In fact, my research indicates that DDD would need to fall to around $35 to justify an investment in that stock. Therefore, I encourage investors and speculators alike to avoid DDD at this time."

In regard to athenahealth, which I wrote about on March 5, I said, ”athenahealth (ATHN) appears to be another of those stocks that seems to have a good story but whose financial operating results and growth prospects don’t justify the company’s stock price.”

I added the following: “My research indicates that athenahealth would need to quadruple its earnings per diluted share during the year ending Dec. 31, and during each of the ensuing two years, to justify the price at which the company’s stock closed on Tuesday [March 4] — at around $204.”

I went on to say, “my experience suggests that the probability for athenahealth to grow its earnings at the rates mentioned above is extremely unrealistic. Therefore, I encourage investors and speculators alike to stay away from ATHN. A better bet, in my opinion, would be for aggressive stock market speculators to sell ATHN short.”

I’m not suggesting that my analysis will always turn out to be correct or that my securities recommendations will always generate positive returns, because they won’t.  That’s because just like anyone else who invests and speculates in the financial markets, I sometimes make mistakes.

That being said, 83 percent of the stocks that I encouraged our readers to purchase in the articles that I wrote for Moneynews during the past few months were up as of April 4, while 72 percent of the stocks that I encouraged our readers to either avoid or to sell short were down.

In regard to the stocks mentioned above, TWTR was down 44.2 percent, ATHN was down 32.6 percent and DDD was down 43.7 percent as of Friday’s close.

Not surprisingly, all of those stocks shared the following characteristic: Their P/E ratios were considerably higher than the projected 3-5 year growth rate of their underlying companies’ profits — financial market participants were overvaluing those stocks substantially.

So, I urge you to not be shaken by Friday’s big drop in the Nasdaq Composite Index.

Instead, I encourage you to use that route in story stocks and other momentum stocks as a learning experience.

Editor's Note: Free Video — ‘Rogue Calendar’ Could Turn 490% Profits

Of utmost importance, I also encourage you to do the following when considering an investment in any given stock: Compare the P/E ratio of a stock that you’re thinking about buying to the rate at which you think the underlying company will be able to grow its net profits, on an average annual basis, over the ensuing 3-5 years — divide the stock’s P/E ratio by your estimated growth-rate for the company’s net profits. Whenever the result is higher than 2.0, I would encourage you to avoid the stock. (Note: I would also encourage you to never buy stocks of companies that are selling for more than $15 per share if their underlying companies have not yet generated a profit).

David N. Frazier has an extensive background in the investment securities industry and has invested in the financial markets for more than 25 years.

In addition to working as a business analyst, merchant banking analyst and equity research analyst, he’s held positions in sales and marketing at institutional investment firms, including William O’Neil & Co., TDAmeritrade, and Merrill Lynch.

David now serves as the president and chief market strategist of Frazier & Mayer Research, LLC (dba www.TheMarketMonk.com), an independent investment research firm that provides research and analytical services to hedge funds, investment advisory firms, and other investment newsletters.


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The Nasdaq Composite Index took a big hit Friday, falling 2.6 percent compared to the prior day’s close in response to sharp declines in story stocks and other momentum stocks.
DavidNFrazier,Story,Stocks,Momentum
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2014-12-07
Monday, 07 Apr 2014 11:12 AM
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