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?!"
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.
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.
Alyce Lomax has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple, DreamWorks Animation, and Netflix. The Motley Fool owns shares of Amazon.com, Apple, Microsoft, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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