Three Scary Stocks for Halloween

10/29/2009 11:00 am EST

Focus: STOCKS

Michael Shulman

Editor, Short-Side Trader

Michael Shulman, editor of ChangeWave Shorts, thinks the rally will run out of steam, and he names three stocks he thinks will suffer when investors get more discerning.

Scary is clearly defined as causing fright or alarm. So, what does it take to make a stock frightening and alarming?

The Street wants to see real growth in 2010, but it will not. And, when the fundamentals catch up—meaning the Street fully evaluates companies on the assumption that the massive injections of liquidity are winding down—there are some truly "scary stocks" that will make us a fortune on the short side.

I'm not ready to move on these stocks quite yet, but, in time, they will become ripe for the picking.

One thing is for sure, though, they all have what it takes to frighten us during the Halloween season. The following companies have nearly everything working against them and, if they've stayed up this long it's only because reality hasn't sunk in.

Palm (Nasdaq: PALM) is the "unfortunate company" that's trying to compete against the iPhone [and] the BlackBerry and Apple's (Nasdaq: AAPL) and Research in Motion's (Nasdaq: RIMM) deep pockets. PALM will not win against such stiff competition.

The company continues to lose money and burn cash. On August 31st, it had $277 million in cash and receivables and $522 million in payables and short-term debt, while long-term debt is $389 million—all for a company that may generate $400 million in revenue next year and perhaps $500 million the year after, but no profits!

[Palm is] a cult stock subject to savage short squeezes that have cost us dearly in the past. We will wait a while longer for it to fall a bit more before we jump on. (It closed above $13 Wednesday—Editor.)

Open Table (Nasdaq: OPEN) is a serious cult stock that's unspeakably overvalued, [but] you can't yet trade options on the stock.

Restaurants, especially higher-end ones, continue to lose business and OPEN is a pure play on the restaurant business. This non-tech outfit is selling for six times revenue and 100x forward earnings based on analysts’ estimates.

Management and other insiders just dumped a humongous number of shares in a secondary offering [that] didn't raise any money for the company; it just let investors and managers get liquid. We will wait for the puts to become available, then we will take the opportunity very seriously. (It closed above $26 Wednesday—Editor.)

Blue Nile (Nasdaq: NILE) is another cult stock. It's well managed and a great brand for those buying jewelry online. The Street sees NILE as a "trading down" winner for people who will buy jewels online to save money, but you need a credit card to buy online and income to back up the credit card—and Blue Nile's core customer isn't the person who will go to Tiffany (NYSE: TIF) while wearing a Hermes scarf.

Consensus estimates has NILE with a forward P/E in 2010 of 62x. No kidding. You should never short on valuation alone, but this company (while a great franchise) has a stock that is due to blow up. The only question is when. (It closed above $63 Wednesday—Editor.)

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