Green Mountain Coffee

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[GMCR  Loading...      ()   ] also strikes me as a cult stock. Although I have always thought the stock was overpriced, I was pretty excited last Christmas to get one of the Keurig one-shot coffee machines.

After a few months, I found myself at Target

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[TGT  Loading...      ()   ], buying a new Mr. Coffee.

The thing was just a pain to use when you drink a lot of coffee. When all the kids are here, there are four coffee drinkers in the house, and a cup at a time is just not practical. The coffee is expensive, and unless you are single and live alone, I don't think the machines make a lot of sense. Sixty times earnings for what is basically a coffee fad has very little margin of safety, in my opinion.

The real problem with cult stocks is that the investors who get caught up in the hoopla do not take the time to do the work. Who cares what the balance sheet looks like or how much stock the insiders are selling? The bear can TALK! The P/E ratio does not matter, the donuts are hot out of the oven! Howard Stern is funny and everyone wants to pay to hear him talk dirty, on their way to work. It is a new paradigm and valuations do not matter for such world-changing companies.

(Paradigm, by the way, is another word for stop-loss for me. If I ever hear the word associated with a stock I own, I sell it.)

The way to avoid cult stocks and the inevitable bad ending is to always do the work. Investing, as Ben Graham pointed out, works best when most business-like. Avoid the hype and the promotion, and focus on the value of the business, and you will never find yourself with a glass of Kool Aid in one hand and worthless stock certificate in the other.

Tim Melvin is a contributor to RealMoney.

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