What We Can Learn from These 5 Losers

05/14/2012 10:30 am EST


Timothy Lutts

Publisher, Cabot Heritage Corporation

They say there's more to learn in losing than winning, and if that's the case, the examination of the following stocks will be very instructional for investors, writes Timothy Lutts of Cabot Wealth Advisory.

I don't typically write about failures in these columns. The mass media gives you enough bad news. But today I'm making an exception. Today, I'm going to analyze five once-popular stocks that hit new lows last week.

Why? To teach you a lesson, of course. Typically, we learn best from our own failures, but that can get expensive in this business. So instead, we'll try to learn from the failures of others. Alphabetical order, then:

Ctrip (CTRP)
This company was once touted as the Expedia (EXPE) of China. Smaller and faster-growing, the company racked up a perfect ten-year record of growth of both revenues and earnings. Cabot Top Ten Trader did very well with the stock in 2009.

But the stock's upward momentum slowed and eventually reversed, and in 2011 there were several technical signs to exit. The chart made lower highs and lower lows, and there were gaps down in May, July, and November.

If you had sold after the first gap down, you would have sold at $44; if you waited until the second gap down, you would have sold at $40. And if you'd waited until after the third gap down, you would have sold at $30.

Lesson: A huge gap down, especially on earnings, is never a good thing—it's a strong suggestion to sell. CTRP is now trading at $20, earnings estimates are being reduced, and there's growing talk of rising labor costs and increased competition.

Diamond Foods (DMND)
As of September 2011, the maker of Diamond brand nuts, Kettle brand potato chips, Emerald brand snacks, and Pop-Secret popcorn was flying high. It had received approval to buy Pringles, had reported record results for fiscal 2011, and had raised guidance for fiscal 2012.

Then the trouble started, with a question about the legality of the company's non-GAAP accounting methods, in which it pre-paid walnut growers for their future harvests.

If you had sold after the company's first explanation of innocence (October 3), you would have sold in the $70s. If you had sold after the stock's first big gap down (a month later, on November 2, when Diamond announced a delay of the Pringles deal), you would have sold at $50. If you waited until news of the SEC investigation surfaced, you would have sold at $26. And if you had waited until the Pringles transaction was actually canceled (February), you would have sold for $22!

Lesson: Just as there's never just one mouse, or one cockroach, there's seldom just one piece of bad news. It often snowballs. And once that trend gets going, it generally goes further than originally expected. DMND is now selling at $21, and pursuing strategic options like being acquired.

First Solar (FSLR)
This firm led the top-performing solar power sector in 2007, soaring from $30 to $267. Cabot Market Letter subscribers bought in March, and saw profits as big as 456% (they were advised to take some profits off the table on the way up) before the stock rolled over in 2008.

Revenues at First Solar have grown every year since then, and the long-term future for solar power remains bright. But all this time, competition has been growing, putting pressure on prices.

FSLR traded sideways for most of 2009, 2010, and the first half of 2011, generally trading between $100 and $150. And then the bears took control, pushing the stock down and down and down. It's now trading under $18, and the sellers are still in control.

Lesson: He who was first will often be last. And once a big winner rolls over, the power of the potential sellers exiting that once-hot stock can overwhelm the power of potential buyers. By many measures, FSLR (now trading 88% off its highs!) is a great value here, but of course people have been saying that for the last hundred points of the stock's decline.

Sony (SNE)
The big dog in consumer electronics once upon a time. In fact, I remember buying three big bulky Sony TVs when my wife and I added to our home in 1995.

But there's a new big dog in town now—named Apple (AAPL)—as well as myriad smaller competitors. So even though Sony had record-high revenues in 2011, earnings have been challenged; they peaked in 2008. As a result, institutional investors have been exiting the stock for years; it's now 45% off its high.

Lesson: Even the best-managed company eventually matures, and as it does, institutional growth investors move to faster-growing younger stocks. If you're a growth investor, you shouldn't hang around the senior citizens center—you should prospect at the high school.

Your online doctor, a free source of information on what ails you, or (ideally) on how you can minimize ailments, has a perfect ten-year record of revenue growth, as well as great name recognition in a crowded, competitive field. But earnings trends have never been steady, and now they're in trouble, with estimates being reduced.

The problem: Advertising dollars are fading, reducing by cutbacks on drug ad spending and migration of the spending to social networking sites. Shares of WBMD topped at $59 last summer; now they're down to $22, having lost an impressive 63% in 11 months as investors leave WBMD like rats deserting a sinking ship.

Lesson: Don't confuse the company with the stock. While you might like the Web site and note that business continues to grow, the stock, looking ahead, tells a different story. (Also, WBMD has had five notable gaps down since last summer.)

Now let's see if we are able to apply any of these lessons to a present-day popular stock that is losing its way.

Green Mountain Coffee Roasters (GMCR)
This was a great hot stock for Cabot Market Letter in 2011, with profits topping 80% in just six months. We sold our final positions in October at $70, as the stock was gathering downside momentum.

A month later it hit $34, which proved to be a floor for five months. Then, just last week, the stock plunged 48% in one day, as expiring patents and looming competition from Starbucks led management to lower its guidance.

Now some folks are asking if GMCR is a bargain here, 77% off its high. Looking at the lessons above, what can we say?

  • One. A gap down is never a good thing. This is GMCR's fourth gap down since November.
  • Two. There's seldom just one piece of bad news. This wasn't the first, and it's unlikely to be the last.
  • Three. He who was first will be last. After a very profitable ten-year uptrend followed by the stupendous performance in 2011, GMCR still has lots of downside potential left. Note: the fact that it's already down 77% doesn't mean it can only fall 23% more. Nope, it can still fall 100% from here (though we're not predicting that).
  • Four. Even the best-managed company matures eventually. This is probably the least applicable, as I think Green Mountain has plenty of growth ahead. But I could be wrong!
  • Five. Don't confuse the company with the stock. Feel free to keep drinking the coffee, but don't let the steam from that brew cloud your vision. GMCR's trend is now down, and the odds are the downtrend will go on longer than most investors currently imagine.

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