Recognize the Value of Booking Profits

 | Jan 17, 2014 | 11:00 AM EST
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The stocks of both Gamestop (GME) and Best Buy (BBY) have cratered this week on the back of disappointing results. This has provided important confirmation for me on two things. First, it reinforces why I am deeply underweight retailing stocks, in particular, and the consumer discretionary sector, in general, within my portfolio. The sector was one of 2013's best performers but valuations have run way ahead of the business fundamentals.

Second, it reinforces my investment philosophy of taking some profits whenever a stock or sector has had a massive run. Both Gamestop and Best Buy more than doubled in 2013 and investors who did not take some profits are probably kicking themselves a bit now.

There were myriad huge winners in 2013 during the market's almost 30% surge. Here are two names that I think will be vulnerable in 2014 if sentiment on their prospects dims even a little bit.

Netflix (NFLX), the leader in video streaming, was up over 250% in 2013 and the shares now sell at an astronomical valuation of 83x forward PE. The company faces increasing content costs as well as escalating competition from the likes of Amazon (AMZN).

It also could be impacted by the recent "net neutrality," ruling as its customers are the biggest users of bandwidth on the Internet by far. There is also precedence for a big drop in its stock price. Netflix dropped by three quarters in 2011 on a botched rollout of a new pricing structure.

Electric vehicle maker Tesla Motors (TSLA) had a blowout year in 2013. The stock was up about 400%. To say its CEO Elon Musk has the Midas touch is like saying Michael Jordan was a pretty good basketball player. This charismatic leader can take every government recall and turn it into an "over the air upgrade."

However, I believe the stock has run way past the company's fundamentals. The market is assigning a $20 billion market capitalization to an automaker that will produce 30,000-40,000 vehicles in 2014. To put that output in perspective, this is bad week in China for General Motors (GM). Tesla also sells for more than 100x forward earnings.

In order to justify this valuation, over time, the company will have to roll out new models at lower price points that can rack up hundreds of thousands of annual sales while maintaining the company's industry leading margins. That's a Herculean task if there ever was one.

The company could hit manufacturing snafus, not be able to maintain margins or sentiment could just shift a bit on the stock this year. The electric vehicle credits that have kept the company marginally profitable are diminishing and will eventually go away entirely. With all the recent talk of "wealth inequality," the politicians may one day target the $7,500 tax credit that is going to buy a vehicle that costs more than the average annual income of the American family. Although unlikely, stranger things have happened.

If you were fortunate enough to ride these or other rockets in the market in 2013, consider paring your holdings. Take some money off the table. Play with the "house" money. No one ever went broke booking profits, it is a sound investment strategy and you might even sleep better at night the next time we encounter a spike of volatility in the market.

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