5 Stocks That Could Crater

01/30/2014 7:00 am EST


Julian Close of MarketIntelligencecenter advises investors not to touch these stocks with a ten-foot pole as he believes they are primed to crash and burn.

The stock market is all fun and games until someone loses their retirement savings. Unfortunately, for less experienced investors, there is no mistake so common as to mistake momentum for safety and grow over-weighted in unsafe stocks. Stay away from these stocks, or it could happen to you.

I'm an unrepentant market bull, convinced that the US has years, yes years, of rising stock prices to look forward to, yet it is in the midst of such good times that the market is most prone to irrational exuberance in the valuation of individual issues. Though full of wondrous opportunities, the market is also full of wondrous folly. Doomed industries are treated as growing ones, losers are given free passes, and criminals are treated as elder statesmen.

1. Netflix (NFLX)
Most stocks fell last week due to a host of negative earnings announcements. One of these negative earnings announcements, though very few have yet recognized it as such, came from Netflix (NFLX), which reported on Wednesday night that it had doubled its subscribers in 2013 and hoped to double them again in the near future. Netflix earned $0.78 per share, crushing the Street's estimate of $0.66 per share and towering over its profit of $0.13 per share in the year-ago quarter. Netflix's CEO Reed Hastings jokingly suggested that HBO's boss, Richard Pleber's HBO Go password was "Netflix Biatch." Zing!

Pick the best possible ending for this sentence: Pride commeth before a…A) Triumph, B) Exoneration, C) Re-doubling of subscribers or D) Fall. If you said D) Fall, congratulations. Hastings's conference call was a troubling mire of hubris even before he got to the biatch thing, and here's why: at $388 per share, Netflix stock has been overvalued by the Street by many multiples, and possibly even an order of magnitude. Behold the price to earnings ratio of 324. Even if you accept the current level of exuberance over Netflix's 2014 prospects, its forecast end of 2014 P/E is 55.

Netflix's earnings report of $0.78 per share may have been more than the Street expected, but it was still a disaster. Feel free to come and tell me when and if the company ever earns $7.80 per share in a quarter (which I highly doubt) and I'll consider reevaluating whether the stock can support a price of $387 per share.

NFLX Daily Chart

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2. Potbelly (PBPB)
Restaurants are just restaurants, but a few recent success stories in recent years have set investors to frothing like Pavlov's dogs. On October 7, PBPB stock began trading at $32.40. Despite a parade of skeptical analysts, investors simply could not be dissuaded from the idea that they held the next Chipotle Mexican Grill (CMG). While time has not exactly been kind (the stock now trades at $22.85), it hasn't delivered nearly the blow it might have, either.

Potbelly includes 300 company owned and 20 franchised restaurants, most in its home-state of Illinois. The restaurant hasn't yet proven that it has the chops to compete against the big boys, much less that it has the capacity to grow its earnings many, many times over in the coming months and years, but if it doesn't then its share price will be unsupportable. A quick note to investors who may be new to the game—the mere fact that a stock has fallen does not mean you're picking it up at a bargain. This is the sort of damn the fundamentals, full speed ahead investing that is normally associated with Chinese Internet social networking stocks. Why it spread to "fast casual" dining in 2013 is anyone's guess, but to be sure, Potbelly is not alone….

PBPB Daily Chart

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NEXT PAGE: 3 More Dangerous Stocks to Own


3. Noodles and Company (NDLS)
You can be forgiven if you were excited about Noodles and Company at some point—I certainly was. It's a restaurant idea that works, and it appears to have caught on with the very important high-school age demographic. The food is tasty too, and as it consists largely of noodles it should be very cheap to make. Throw that together with a great looking growth rate and you've got the recipe for the next Chipotle, right? Actually, there are several problems with that assessment, but let's begin with the most obvious: the valuation.

What I would dearly love to see is growing restaurant chain emulate Chipotle's price to earnings ratio which, at 38, is high, but at least not ridiculous. At 165, Noodles's price to earnings ratio is even less justifiable than Potbelly's. The company will have to double in size four times before we can even begin to consider the problem ironed out. Worse, however, is the company's operating margin of 5.8%. It should be easier than that to make money selling noodles. Chipotle's operating margin, for example, is 16%. Unless Noodles and Company can operate at that level, there is no reason to think it will ever grow enough to justify its price.

NDLS Daily Chart

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4. Great Northern Iron Ore Properties (GNI)
On April 6, 1995, the last of 18 persons named as trustees of Great Northern Iron Ore Properties died. In accordance with the trust agreement, the trust will terminate on April 6, 2015, the 20th anniversary of that death. Investors have been attracted to GNI stock due to its high dividend yield of 14.4%, and this is unfortunate, since if they hold off a bit longer, the dividend yield will undoubtedly rise to nearly 100%. I'll explain…

For those not familiar with the way a terminating trust behaves, it acts much like a managed payout fund. The dividend is being paid out of the sale of assets and the management of the company makes no bones about it. Nor are they attempting to hide the fact that after April 6, 2015, GNI stock will no longer exist. That's right, here is one occasion on which I can actually promise that the stock is going to zero.

Of course, between now and then, the company will pay out everything it can in dividends. That's part of the problem, however. The company's balance sheet indicates net tangible assets of $9.399 million, with 1.5 million shares outstanding. Using the power vested in my solar-powered Office Depot calculator, I conclude that the company has $6.27 in assets per share. It also earned $9.78 per share last year, and it expects about the same, or a bit better this year. Even assuming that GNI has a prosperous five quarters remaining to it, however (which fudging a bit in its favor) I'm only coming up with about $19 per share in total possible pay-outs before the stock ceases to exist, yet even after having lost most of its value earlier this month, GNI is still trading $22.43. The difference between those numbers is what we in the market might, if feeling uncharitable, refer to a "noob tax."

GNI Daily Chart

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5. Yamana Gold (AUY)
Nothing gets a pessimist's goat like optimism, and the generally rising sentiment about the world's economic outlook has caused a minor feeding frenzy at the gold (GLD) trough. $1,263 per ounce may not seem a fortune for gold, especially given what gold bulls themselves were predicting not long ago, but it is likely a last gasp for gold before it gives back the irrationality of the last five years, with interest. Gold mining companies, for the most part, bought into the idea of $3,000-per-ounce gold as deeply as anyone, and most made some very bad investments as a result. For Yamana Gold, the trouble began, in the form of declining profits, way back in 2012, when gold was still selling at a far higher price than it is today.

AUY Daily Chart

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Yamana was hit hard in the gold-bear market of 2013, but for reasons unclear, it has been rallying so far this year. I see nothing exciting in the company's numbers or its prospects, and my sentiments were echoed Thursday morning by HSBC, which lowered its rating on the stock to underperform, based largely on concerns over the sustainability of its El Penon mine. Here is a company which will almost certainly cease to exist if the price of gold should fall much further from its current levels, and which had a hard time making profits when times were good.

The Street is ignoring the HSBC downgrade. I'm cautioning investors not to.

By Julian Close of MarketIntelligencecenter

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