The Fading Stars

 | Jun 11, 2014 | 2:00 PM EDT  | Comments
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Stock quotes in this article:

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A lot of research has been done on the subject of value and momentum investing. Yesterday I looked at some cheap stocks that had been lagging behind and were starting to move higher in recent weeks. Last night, it occurred to me that the opposite was probably an equally sensible approach to take to trading and investing in stocks. If a market-leading stock that has had a huge run over the past year or two suddenly starts underperforming the broader market, it might be time to consider selling your shares or even shorting the stock. If the piles of institutional money suddenly abandon a high multiple stock, it could be a long drop to reach rational valuations for the business. I sat down this morning and looked for some fading stars investors might want to avoid or sell.

Wynn Resorts (WYNN) is a classic example of this type of stock. It had powered higher for a couple of years as hopes of huge gains in the Macau gaming markets caused investors to  bid the shares up to some pretty high valuations. The price had tripled over the past few years and the PE ratio was close to 30 at the peak. Now the Chinese government is cracking down on the region and restricting the amount of cash Chinese gamblers can bring to the gaming mecca. The growth and momentum crowd that had bid the shares up have been quick to jump out of the stock and Wynn shares are down 20% from the 52-week high. With the stock still trading at more than 25 times earnings and carrying a PEG ratio of over 2, it is hard to see who is going to bid the stock back up anytime soon. Insiders do not seem too excited about the prospects for the company as they have been steady sellers of the shares since early February.

Wendy's (WEN) is another great stock story that provided investors with handsome gains the past couple of years. Now the momentum is fading and some of the momentum crowd is abandoning the stock. Wendy's has been revamping its stores and image but it remains to be seen how successful the reworking will be for the fast food company. I am not so sure that a pretzel bacon cheeseburger is the wave to the future, and apparently neither are many investors. After doubling in 2013, the stock has fallen off of late and is down about 10% in the last three months. It is still not cheap at more than 35 times earnings, so I don't think value types will come to the rescue and bid the shares back up anytime soon. With a PEG of more than 2.5, I doubt that the growth and reasonable price crowd of mutual fund managers will be pouring money into the shares either.

Shutterstock (SSTK) was one of the biggest hits among tech stocks offerings in the past few years. It has a huge database of photographs and videos it licenses to customers to use in advertisements, web sites and other places. It recently moved into the music licensing business as well. The shares had been a favorite of the momentum crowd as the exceeded earnings estimates several quarter in a row and kept hitting new highs throughout 2013. In the first quarter the company merely matched expectations and that is often the beginning of the end for a momentum name. After more than tripling in 2013, the stock is down a little over 10% in the past three months. At more than 100 times earnings it is impossible to make a case for it based on valuation crowd, and the momentum folks won't be back until it starts exceeding Wall Street's expectations again.

RigNet (RNET) has what I think is a great business. It provides network infrastructure services for the remote communications needs of the oil and gas industry. It provides voice and data services to the offshore platforms and remote locations, as well as internet access to these locations. Unfortunately as with every great business idea that is showing strong growth in the near term, the stock has been priced for perfection and perfection cannot be maintained forever. The company missed earnings expectations in the quarter, and the momentum crowd has pretty much abandoned the stock. After almost tripling in 2013, the stock is now down 10% in the past quarter; but it is still expensively valued, with a PE of almost 60.

The idea of combining value and momentum makes a certain amount of sense. It appears to me that you invert the basic idea and also spot undervalued stocks that are in the process of falling out of favor.

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