Thursday, May 3, 2012

Selling Into Bubbles...When Do You Pull The Trigger?

Here's a company with a declining moat, accounting discrepancies, inventory Three Card Monte, brilliant short-sellers vocally involved and a looming patent expiry on the bread-and-butter product line...
And you have Buy and Hold ratings on the stock?  What do you do for a living?
Read it at The Reformed Broker
You Are Now About to Witness the Strength of Street Knowledge
By Joshua Brown

A few years back (in 2009) a friend asked for my opinion on whether or not to invest in a company called Diedrich Coffee (Ticker: DDRX). The company sold coffee in small, single cup containers that can be used in various coffee machines, including the popular Keurigs. Looking at the company’s financials and considering the line of business, I was reminded of Jones Soda (ticker: JSDA) and suggested avoiding the stock. Jones Soda has a unique brand of flavored sodas that garnered a significant amount of hype back in 2006, including frequent promotions by Jim Cramer on CNBC’s Mad Money (I’ll admit I used to watch). Here’s the chart I was thinking about (courtesy of Bloomberg):
As you can see, the stock doubled from 5 to 10 during 2006 before shooting up above 30 in April of 2007. The company’s earnings, however, failed to come even remotely close to meeting the grandiose expectations. A year later the stock had dropped more than 90% from its peak and today is trading around $0.40.

My recommendation on DDRX proved incorrect, as the company was purchased a year later by a bigger player in the same industry, Green Mountain Coffee Roasters’ Inc. (ticker: GMCR). At that time, in May 2010, the single cup coffee industry appeared poised to take off with GMCR as one of its leaders. Again I did some research on the company and industry, noticing almost unanimous enthusiasm from wall street analysts. Regardless, my conclusion remained the same. For over a year it appeared I was terribly wrong as the stock soared from $25 to over $115 in September of 2011.
But then a funny thing happened, earnings started to falter, there was some bad press and the stock began to fall rapidly. After stabilizing for a few months, the stock plummeted again following last night’s earnings report.
Two years after my initial review, the stock is back to $25. So was my call correct? I guess that depends on one’s time horizon. How many investors who purchased the stock on the way up were wise enough to get out with a profit? How many investors are still left holding the stock with large losses? What do those investors do now...take the loss or hold on and hope things turn around?

Personally, these types of scenarios represent a wonderful learning opportunity. Knowing when to sell is possibly the most difficult part of being an investor. When the fundamental story appears flawed, deciding when to sell becomes nearly impossible since a buying frenzy can often reverse even more quickly. My takeaway (which I learned the hard way) is to always be skeptical of investment research and to avoid speculating during buying frenzies, saving myself the trouble of determining when to sell. What lessons do you take from this scenario?

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