Stay Away From "Seriously?!" Stocks

A bull market makes investors feel great. Awesome returns across the stock universe can make everybody feel like a genius, and that investing in stocks -- even fairly indiscriminately -- is a sure bet.

Feel-good times create a problem that's easy to overlook. Take a close look at quite a few stocks these days and many companies' stock prices have little or nothing to do with actual business quality or financial success.

Beware the stocks for which common sense dictates the following response: "Seriously?!"

Huh?
Best Buy (NYSE: BBY  ) comes to mind as one of the high-profile examples. The stock has skyrocketed in recent months, and that's despite the fact that there's no real proof of a turnaround in sight.

The electronics giant's most recent quarter should have been viewed as a major disappointment. Sales and profit dropped, as did same-store sales. It's losing ground fast. However, the stock has surged by 36% in the trailing-52-week period, with most of the gain having taken place in the last several months.

Maybe some investors are heartened by recent news about Microsoft stores-within-stores, as well as Samsung's entry into Best Buy outlets. However, I'd question such assumptions as all that helpful to growth for Best Buy. For example, Microsoft's cool cachet doesn't hold up to a company like Apple. And if customer traffic's dragging, even an enhanced experience will mean little  anyway.

What?
Conn's (NASDAQ: CONN  ) is another denizen of the electronics retailing space and adds furniture and appliances to its offerings. The insane trajectory of Conn's share price is quite frankly mind-boggling. The stock has more than doubled in the course of the last 12 months.

The eyebrow-raising aspects go beyond the simple fact that this consumer segment isn't an easy one, especially taking into account the renowned "showrooming" effect that drives customers to Amazon.com (NASDAQ: AMZN  ) .

Conn's direct lending to its customers differentiates it from rivals -- and makes it riskier, too. Last year, it financed 71% of its retail sales. According to Conn's most recent Form 10-K, the majority of its customers had credit scores between 500 and 650, below the score considered a very good credit history. Those who don't make the grade can take advantage of rent-to-own arrangements. According to Conn's 10-K risk factors, many of its borrowers would be considered "subprime." That should ring a bell, and not in a good way.

Lending and consumers' ability to actually pay back borrowings is a significant factor. The possibility of rising interest rates and continued pressures on consumers in the real economy creates uncertainty that Conn's skyrocketing growth is wired to last. Conn's growth is being financed, its stock is on borrowed time, and like the market rally, that party looks destined to come to a screeching halt.

In other words: Seriously?
Those who invested in Netflix (NASDAQ: NFLX  ) at its 52-week low of $53 must be feeling pretty good right about now. Too bad the stock's valuation is currently insane.

Netflix's current forward price-to-earnings ratio is 65. High price-to-earnings ratios can sometimes be justified if investors believe growth expectations are far too low at the moment. However, I don't see any reason to argue in favor of high growth rates for Netflix right now.

Bulls loved today's announcement that Netflix and DreamWorks have made a major deal for original content, but Netflix still has Amazon breathing down its neck. Amazon tends to get a lot of the hottest new programming before Netflix's streaming service does, and at some point, consumers will tire of a service that often doesn't carry the content they desire.

Netflix head Reed Hastings may have talked up "binge viewing" in recent months, and although I've indulged in that behavior using Netflix once in a while, it's usually for very old shows. When it comes to the hottest shows that I've wanted to catch up with now, to talk to friends about -- Game of Thrones being the most recent example -- I've had to turn to Amazon. I doubt I'm the only one.

The Netflix of yore differentiated itself with its new offerings as well as a back catalog of great content on DVD. Back in those days, it put Blockbuster to shame when it came to breadth and depth of content. In the streaming world, it's been much more difficult for Netflix to offer a product that's so positively positioned compared to rivals. The new Netflix will not be the strong grower it used to be.

Netflix's current price makes it a "Seriously?!" stock.

Gearing up for serious pain
Bull markets make investors happy, but that can be a huge problem. Investors should be more careful than ever when they're searching for solid long-term investments when every stock seems to be heading for the skies. 

The examples I've chosen above have a common thread: Amazon's threat. Amazon's actually a more rational stock, despite its forward price-to-earnings ratio of 84, (which is only a tad higher than that of Netflix). Its entire business is far more diversified, adding security. It doesn't have to pull off a turnaround or offer its customers credit to buy its products. In fact, it has a slew of very loyal customers through its Amazon Prime service, which makes it the logical consumer choice for many people right off the bat.

Generally, it's a crucial time to assess stocks and make sure their returns haven't been juiced despite very little true business quality or financial success. Long-term investors who have seen the market's ups and downs and propensity for near-term insanity would say, "Seriously?!" about many stock prices today. When the party's over, many investors could end up in a world of hurt. Seriously.

Can Netflix fend off its burgeoning competition, and will its international growth aspirations really pay off? These are must-know issues for investors, which is why The Motley Fool has released a premium report on Netflix. Inside, you'll learn about the key opportunities and risks facing the company, as well as reasons to buy or sell the stock. The report includes a full year of updates to cover critical new developments, so make sure to click here and claim a copy today.


Read/Post Comments (8) | Recommend This Article (2)

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  • Report this Comment On June 17, 2013, at 4:56 PM, stan8331 wrote:

    Strongly agree with you on Conn's and Best Buy. One of my all-time worst retail experiences was at Conn's, and the lack of any corporate response whatsoever to my complaint letter (I've probably written fewer than five in my entire life) was telling. Best Buy just seems antiquated and full of over-priced merchandise. They may find some way to successfully reinvent themselves, but I surely wouldn't bet on it.

    Very strongly disagree on Netflix. That new content you're getting from Amazon doesn't come along with their Prime subscription - you're paying extra for it. Netflix was NEVER a great deal for folks who mainly wanted to see blockbusters as soon as they were released to video. My Netflix streaming queue is upwards of 250 - my problem is I'll never have enough time to watch it all. I still have a Netflix DVD subscription as well, but don't get nearly as much use out of it vs.the streaming. Netflix is still building out their international component. As those markets move forward in time, net revenue will begin to grow at a rapid pace. The stock COULD be over-priced right now, but I am much more comfortable owning it than I would be with selling and hoping for another precipitous drop. If it does fall back below $100, I'll be buying more.

  • Report this Comment On June 18, 2013, at 10:28 AM, TMFLomax wrote:

    Thanks stan8331! Good thoughts and I do understand that lots of people have differing opinions on Netflix... and your points are sound!

    Glad you agree on two of these though. ;) Yeah, I definitely find Conn's model very disturbing, and I find it interesting that you had a poor experience at Conn's ("interesting" as in ominous for that business). I don't have any firsthand knowledge of Conn's, as far as I know there isn't one near me (but maybe there is, I should look into it). I really find it disturbing it has skyrocketed so much, and the reliance on financing seems very precarious...

    Best,

    Alyce

  • Report this Comment On June 18, 2013, at 10:30 AM, jpanspac wrote:

    I think you can add AMD to the list.

  • Report this Comment On June 18, 2013, at 10:43 AM, craigbutelo wrote:

    Alyce,

    Good article.

    I think that a poster child for over blow returns might be HP. I am making money but wondering why. With billions of debt in blue sky (from over priced purchases) and a shrinking demand for lap tops and no forward plan to add tablets. The big question is when do I sell ?

    Craig (No College)

  • Report this Comment On June 18, 2013, at 11:13 AM, TMFLomax wrote:

    Thanks for the new candidates for a list like this! Yeah, there are a ton out there, so thanks for filling in some of the (many) blanks.

    Craig, the fact that you're wondering when to sell is an awareness that I'm afraid too many people lack these days, so good for you! It is a huge deal to be able to look at your own stocks and wonder, even if you have great returns. And it does make it harder to make a sell decision when the overall market keeps bubbling higher. I can't say when anyone should sell per se, and the market does weird things in the near term; I've been questioning this bull market for a long time, and obviously it hasn't ended yet, despite pockets of weakness like last week's. However, asking the question is a great start. It's everyone's personal decision, and I know it can nerve-wracking. I can't speak of HP specifically, but the factors you mention are solid ones for concern for any company.

    I think generally some people could think about selling partial positions if they're undecided. A lot does depend on time horizon and whether one has the inclination to ride it out for the long term (through ups and downs) and my personal stance is that if one has the best companies in their portfolios, they have additional protection despite ups and downs. I admire you for questioning one of your own holdings' true business quality and future growth plans (or lack thereof). That's what this article is all about.

    Best,

    Alyce (who thinks that college is often overrated, especially given the price of it these days, and self education and experience can certainly make up for lack of a college degree -- couldn't help but touch upon No College. :))

  • Report this Comment On June 18, 2013, at 2:34 PM, setx0613 wrote:

    From what I've observed, Conn's has been very successful at creating customer loyalty. Low income people are happy to have a company give them credit, so they don't want to lose that opportunity to be able to buy appliances and television sets when they need them. I know it seems crazy, but it seems to work. Also, they are tough taskmasters when it comes to setting goals for their salesmen. Customers in Beaumont, Texas, where the company started also love their service. Places like Best Buy do not have the local service workers to make house calls and Conn's does.

  • Report this Comment On June 19, 2013, at 9:05 AM, TMFLomax wrote:

    Thanks setx0613... another good observation. I was thinking about the financing element later yesterday and that it would definitely help some people get some important things they may not otherwise be able to get... still, I can't get over debt being a killer and the risk of delinquencies.

    Still, whew, that stock price!

    Best,

    Alyce

  • Report this Comment On July 12, 2013, at 10:43 AM, wetoasis wrote:

    I think you should be fired for writing this. Look at how much NFLX goes up now.

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