Think of Green Mountain Coffee Roasters Inc. (Nasdaq: GMCR), Groupon Inc. (Nasdaq: GRPN) and Zynga Inc. (Nasdaq: ZNGA).
Retail investors flocked to all these stocks, only to get burned: All three collapsed.
But investors eager to jump in to the markets during the strong start to this year need to be careful: Many stocks that seem attractive to retail investors are actually seductive traps.
The five stocks below have made amazing gains in relatively short time spans, leaving investors who missed out wanting to cash in on the companies' success. Plus, investors often like to shop at these companies or use their products, making the stocks appear even more appealing.
But you'd do well to stay away from these overvalued stocks with poor long-term prospects.5 Overvalued Stocks to Steer Clear Of
- Lululemon Athletica Inc. (Nasdaq: LULU) - With a recent price of $69.95 Lulu is down more than 13.5% from its 52-week high, but don't be fooled, it's not a buy. Since going public in August 2007 the company has gained more than 400%, and investors who picked up shares at $2.25 in March 2009 have made over 3,000%. Lulu's run has been impressive, but the yoga apparel company screams of fad, and eventually its stock will fall.
With a P/E ratio of 43.47 it has one of the lower valuations on our list, but nonetheless it is still high. "The key for investors to remember, the higher the valuation, the greater the expectations; the greater the expectations, the greater the downside risk," Charles Rotblut, editor of AAII Journal told MarketWatch. "That really applies to [Lululemon] right now. People are expecting strong growth to continue, growth that exceeds their expectations, and that starts getting the stock into a dangerous game of hot potato, where you don't want to be the last person holding the stock."
- Research in Motion Ltd. (Nasdaq: RIMM) - After nearly falling below $6 this fall, RIMM almost tripled from its lows in less than four months. Now trading at $15.30 the stock is still overbought. Not even the release of the Blackberry 10 will save the company, which has seen its global market share in smartphones decline from 20% to fewer than 5% in just three years. RIMM does not earn a profit but if it did, its P/E would be sky high.
- Amazon.com Inc. (Nasdaq: AMZN) - At $270 Amazon has a P/E ratio of 3,375, making it technically the most overvalued stock on the list. Amazon is up 43.6% from a year ago and last week it reached its all-time high of $284. That price could be the peak for AMZN stock as the company's low-cost advantages are starting to decline.
New tax laws in Pennsylvania, Texas and California are now requiring Amazon to start collecting a sales tax from its customers, and more cash-deprived states should follow in that trend. Higher energy costs could cause Amazon to charge more for shipping, further angering customers. Amazon is also facing stiffer online competition from retailers such as Wal-Mart and Target. And some retailers, including Target, are matching or beating the price of Amazon products in its stores. These factors should help bring the company's P/E, and stock, down to realistic levels.
- Netflix Inc. (Nasdaq: NFLX) - In the last three months Netflix has been on a tear, gaining 135%. At $164, NFLX is far from its all-time high, which is just below $300. But with a P/E of 567, its stock is certainly overrated.
Perhaps the most dangerous risk for Netflix and its investors is that the company could easily go the way of Blockbuster and the VCR. Netflix relies on other companies to provide its product, video content. Just one or two innovations that change the way consumers purchase that product will severely cut into Netflix's subscriber base and its stock price. Plus the company continually faces strong competition from Comcast, Verizon and other digital media providers.
- Chipotle Mexican Grill (NYSE: CMG) - Before last summer's drought increased chicken and beef prices, eating away at Chipotle's bottom line, the company was trading above $400. Now at $310, Chipotle s P/E has dropped to 38, but its stock is still up more than 500% in the past four years. With same-store sales growth slowing to just 4.8% in the third quarter of 2012 from 8% the previous quarter, Chipotle is struggling to continue its growth story. Investors thinking about buying CMG now that it has fallen would be wise to avoid the stock, especially considering the company's 2013 outlook calls for flat to low-single digit growth in same-store sales.
If you're looking for more advice on popular stocks to avoid, read this article by our Chief Investment Strategist Keith Fitz-Gerald. He explains why the Apple sell-off is just beginning.
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