Rise of the Left-for-Dead Growth Stocks

Learning to spot developing trends in equities is just as important as learning which stocks to buy or sell. It is a known fact that equity markets are cyclical in nature; they begin with accumulation, then distribution, and finally end with painful capitulation.

With specific regard to high-flying growth stocks or momentum stocks, however, there are undeniable trends worth monitoring. I find that many of these stocks trade in tandem with one another, and this theory has never been made more apparent to me than with the high-flyers of 2011.

The momentum stocks
The more prominent super growth stocks of 2011 include:

  • Chipotle Mexican Grill (NYSE: CMG  )  owns and operates fast casual Mexican restaurants. The company is best known for its build-it-yourself burritos/tacos and a focus on naturally raised meats and organic produce.
  • Green Mountain Coffee Roasters (NASDAQ: GMCR  )  sources, produces, and sells a variety of specialty coffees, cocoas, and teas. It is best known for its K-cup and Vue single-serve beverage packs and brewers.
  • Monster Beverage (NASDAQ: MNST  )  develops, markets, sells, and distributes products in the alternative beverage category. Monster is the main competitor to Red Bull. The company's signature Monster brand of energy drinks account for approximately 40% of the entire energy drink market.
  • Netflix (NASDAQ: NFLX  )  provides a subscription-based Internet television service directly to consumers via TV, computers, and mobile device platforms. Once known solely for its DVD-by-mail program, the company now primarily streams content to viewers and creates original programming of its own.

In the several years following the financial collapse of 2008-2009, these four growth stocks went on to outperform the general indices by a wide margin. The following is a breakdown of each company's stock's approximate percentage return from January 2009 to its respective peak:

Company

Chipotle

Green Mountain

Monster

Netflix

Return

565%

1,125%

330%

870%

There were several other stocks that traded alongside these high-flyers in 2011, but the four aforementioned equities always seemed to be on investors' minds.

Left for dead
In mid-2011 for Netflix and Green Mountain and in mid-2012 for Monster and Chipotle, the momentum suddenly stopped. On the heels of subpar earnings results and bad press releases, the stocks' increasingly high valuation multiples and rising short interest led to a changing of the guard. Each of the four equities proceeded to plummet more than 40% in months.

After reaching a high of approximately $300 in July of 2011, Netflix declined a staggering 80% in the following four months. Similarly, Green Mountain fell over 60% in the two months after the stock hit a high of just over $100 in September of 2011.

The next year Chipotle and Monster suffered the same fates, and the percentage losses and timeframes were remarkably similar. Shares of Chipotle dropped 45% in the six months after the stock made a yearly high of $440 in April of 2012. Monster dropped approximately 45% in the six months after the stock made a high of roughly $78 in July.

In each instance, the companies witnessed swift and massive drops in stock valuation as investors shaved off billions in market cap in just days. While most investors left the stocks for dead, the turnaround was soon at hand.

Why it matters
After bottoming out, all four stocks soon settled down and resumed their march upwards. Netflix and Chipotle have since reached new all-time highs in astounding fashion. The stocks are up 363% and 80%, respectively, in 2013 alone. Monster and Green Mountain have both retraced approximately 50% of their losses over the last few years, and may be primed to achieve new all-time highs soon.

The turnaround for each of the stocks started when investor sentiment was seemingly at its lowest point, which is an early sign of capitulation. More importantly, however, is that the management teams at each company successfully resolved the major impediments to growth. For instance, Netflix management lessened its dependence on costly deals with studios by generating its own original content, and the company is now in a much stronger position because of it. Management at Chipotle successfully reversed the tide of its declining same store sales growth by increasing foot traffic significantly, and even managed to keep a steady pace of new store openings in the process, which bodes well for the company's future growth prospects.

Monster faced a few different hurdles, namely legal problems and bad press surrounding the deaths of five people that were allegedly caused by the company's signature energy drink. While much of the evidence suggests that the company was not at fault, management fought the allegations nonetheless, and the stock's drop seems to have been a classic case of overreaction by investors. The stock is now cheaper than it has been in a long time considering it is still projected for solid growth going forward. Similar to Monster, Green Mountain faced a multitude of challenges seemingly all at once. The company came under serious scrutiny from activist investor David Einhorn for a supposed lack of transparency in its filings, as well as lack of support from two of its main distributors--Kroger and Safeway. To combat this, management at Green Mountain started to expand internationally, which subsequently lessened the company's overall dependence on distributors and has allowed the company to expand its global footprint. 

The most important thing for investors to take away is that equity rotation does occur, especially with momentum growth stocks that require a high risk tolerance. Investors can and should prepare for such scenarios by actively tracking stocks that trade in tandem with one another, as they may be able to preemptively signal trouble ahead or indicate lucrative opportunities going forward.

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