Recent violent drops in stocks such as Green Mountain , Chesapeake Energy and Netflix are tempting value investors to go against one of the oldest sayings on Wall Street: “Don’t try to catch a falling knife.”
“In buying falling knives, you have to distinguish between just setbacks and atrophy of business model,” said Stephen Weiss, hedge fund manager at Short Hills Capital Partners and veteran of Street research and trading desks.
In the latest example, shares of Green Mountain Coffee Roasters lost almost half of their value at their low Thursday after the maker of Keurig brewers and K-cups missed results and aggressively cut their sales outlook. The selling picked up following a conference call where executives seemed unable to even find an actual reason for the revenue shortfall.
Our new $40 price target “is based on 14 times our full year 2013 EPS and incorporates the company’s lowered guidance for the current year,” said Nicole Miller, Piper Jaffray’s Green Mountain analyst, in a note to clients Thursday. While Miller downgraded the stock to “Neutral”, her new target (down from $65) represents a more than 45 percent surge from its price today.
Shares of Chesapeake Energy, the 2nd largest natural gas producer in the country, dropped 20 percent from its high on Tuesday to its low a day ago after it missed earnings resultsand Reuters discovered CEO Aubrey McClendon was running a $200 million hedge fund on the side that invested in the same commodities that the company produces.
This follows an even bigger slide over the last month after the board said it learned McClendon was using the company’s wells as collateral for personal loans.
“Green Mountain is completely broken,” said Robert Sinn, trader and author of “The Stock Stage” blog. “The most interesting to me is Chesapeake as some resolution to the issues surrounding McClendon will likely lead to a 15 to 20 percent bounce. But on the other hand, this stock could be dead money as long as the stories keep coming out on him.”
Chesapeake shares jumped as much as four percent today after Bernstein upgraded the shares, saying “we believe the anticipated risks of the unanalyzable do not outweigh the upside potential of the analyzable at this point in time.”
Other “falling knives” over the last month following earnings or other issues include Zynga , Netflix and Polycom . All three are down about 30 percent in one month.
“Zynga is misunderstood, largely due to their reticence to share much information about their business, but I think that they benefit immensely as a derivative play when Facebook goes public,” said Michael Pachter about the online game maker. However, the Wedbush Securities media and social network analyst believes the market is right about Netflix and that the entertainment streaming company may drop another 40 percent in 12 months as competition and costs rise.
Shares of videoconferencing company Polycom got slammed two weeks ago after earnings and revenue missed analysts’ estimates on increased competition from Cisco .
“The move is overdone to the downside,” said Karen Finerman, who runs Metropolitan Capital Advisors, a hedge fund with a value investing focus. “They are the only pure play in the space and the balance sheet is beyond rock solid—tons of net cash.”
To be sure, many investors believe this is not the right time to play this game, especially when so many other stocks keep going up or have the potential to go up without the same amount of risk. The Dow Jones Industrial Average hit a four-year high on Tuesday.
“Why would you do this when you can buy Starbucks , Visa , McDonald’s -- all of which have lagged and are long term winners?” said Stephanie Link, director of research for TheStreet. “Stick with quality leaders.”
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