Don’t Drink the ‘Cool-Aid’

When we were teenagers, it was all about fitting in. We needed the right clothes, the right hair, the right car. We looked up to the popular kids and would have done just about anything to get in their exclusive club. Now that we’re all grown up, it always amazes me when investors blindly follow the “popular” stocks, i.e., cult stocks, regardless of their fundamentals. And just like high school, while the ride may be fun for a while, eventually it will come to an end.

The stocks on this list have been immensely popular with investors, and while I’m not saying they couldn’t go any higher, the upside potential in each is very limited, whereas the downside risk is substantial. I used simple, back-of-the-envelope methods to calculate upside and downside targets for these cult stocks. First, I looked at the upside using the current trendline and past highs, and then looked at analyst estimates for real-world growth in the company. For the downside, I estimated the price based on a return of the valuation of the company to segment and market norms. Yes, admittedly, this contains a lot of speculation and opinion, but any of these overpriced cult stocks could blow up on bad news. If I were you, I wouldn’t drink the “Cool-Aid.”

Baidu.com (BIDU)

China’s leading search engine Baidu.com (NASDAQ: BIDU) is the next Google (NASDAQ: GOOG), right? Currently above $105, the stock is up 40-fold from its 2005 IPO. Baidu is a great brand … in China. End of story.

So if you believe the great China growth story is going to slow — or even blow up like I do, and more importantly, like legendary short sellers Jim Chanos and Mark Hart do — then Baidu will blow up with it. And with a P/E ratio of 88 and a market cap of $37 billion, this could mean a world of hurt for anyone who remains long the stock.

Current price: $106.25
Potential upside: $130
Potential downside: $20

Chipotle Mexican Grill (CMG)

Chipotle Mexican Grill (NYSE: CMG) has risen to cult dining status as well as cult stock status. People are crazy about Chipotle burritos, and investors are even crazier about the stock, which hit an all-time high this year at $262.77, and is currently trading above $225.

The company has excellent management and is in decent shape, masking slow growth in same-store sales with continuing expansion financed with free cash flow and stealth price increases. The question is, how long can they keep this up? Bulls argue the company can lock in very low-cost leases due to commercial real estate depression, while bears argue CMG’s growth and, therefore, its multiple is unsustainable.

What it boils down to is this: Investors face limited upside potential and big downside risk in this stock. The risk/reward ratio is simply not on the bulls’ side.

Current price: $229.64
Potential upside: $250-$265
Potential downside: $70

First Solar (FSLR)

For a while there, being environmentally conscious actually was the cool thing to do. People were trading in their SUVs for hybrid cars, getting all hyped up about renewable energy, and looking for any way to “go green” (provided it didn’t cost too much or inconvenience their lives too greatly). And when it came to “trading green,” the renewable energy cult was all about First Solar (NASDAQ: FSLR).

Unfortunately, government funding for renewable energy is waning, and with natural gas prices so low, it seems silly to subsidize overly expensive solar systems. First Solar may be the world’s leading manufacturer of thin film photovoltaic (PV) modules, i.e., solar panels, but that won’t be much consolation as business turns down. The stock’s current valuation appears reasonable; unfortunately, it is the future that is dark.

Current price: $141.55
Potential upside: $275
Potential downside: $65

Harley-Davidson (HOG)

You can’t get much cooler than Harley-Davidson (NYSE: HOG), now can you? This was the most shorted U.S. stock in 2009, but to no avail, as HOG-loving investors pushed the stock up despite serious fundamental issues. What issues? Well, back then the company was borrowing money from Warren Buffett — at a 15% interest rate! And they were one of the first to line up for a government handout under the Fed’s TALF program.

These days, HOG’s balance sheet is still a mess. The company has an enormous amount of long-term debt and pension liabilities totaling more than $5 billion. And worldwide sales decreased by 7.7% compared to the previous year.

Bottom line: If you want to look cool, buy the bike, not the stock.

Current price: $36.91
Potential upside: $45
Potential downside: $10-$12

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Lululemon Athletica (LULU)

The popularity of Lululemon Athletica’s (NASDAQ: LULU) trendy, yoga-inspired athletic apparel has exploded in the past year and a half — and so has the company’s stock, which surged from under $5 in March 2009 to over $70 today.

The company is still growing and still spitting out profits; however, it is not growing fast enough, or evenly enough, to justify a trailing P/E ratio of 54. I believe brand familiarity, not numbers, is what is keeping the stock up. But how many tangerine workout leotards does one person really need?

Current price: $71.76
Potential upside: $90
Potential downside: $30

Netflix (NFLX)

While the “cool kids” may be out on the town on Friday night, the majority of us are at home sitting on our couches, and very likely watching movies we’ve rented from Netflix (NASDAQ: NFLX). Investors seem to love Netflix as much as its 12 million subscribers. The stock has been helped along by takeover rumors (which ain’t gonna happen at this valuation) and the company’s move into the streaming video business.

NFLX is trading at 72 times earnings, and I think the prospects for growth are diminishing. And while I always say you should never short a stock based solely on valuation, you should also never invest in a stock when one negative announcement could put a hefty dent in the share price.

Current price: $191.49
Potential upside: $250
Potential downside: $40

OpenTable (OPEN)

Online restaurant booking software stock OpenTable (NASDAQ: OPEN) provides a terrific service, but like Netflix, it has achieved cult status because so many people use it. The stock is overvalued — a company with $4 million in quarterly earnings should not command a market cap of $1.84 billion.

A day of reckoning is coming. Growth will slow simply because they already have so many restaurants and people who eat out regularly in the bag. And the stock could lose 50%-75% of its value and still trade at a multiple higher than most service companies.

Current price: $79.74
Potential upside: $100-$110
Potential downside: $25

Pfizer (PFE)

At one point in time, Pfizer (NYSE: PFE) was the most owned stock in America — making it the cult stock. It is still favored among many investors due to its history and excessive dividend yield.

The company’s big problem is that Lipitor, the best-selling cholesterol drug, which accounts for more than $12.4 billion in revenue, will lose its patent protection this year. The company has chosen the worst of all possible partners, Ranbaxy Laboratories, to create an “authorized generic,” has no replacement for Lipitor in the pipeline, has revenues that are otherwise flat to down, and can only lay-off people for so long to maintain that 4%-plus dividend. Most analysts are of the opinion that Pfizer “will figure it out.” I’m not one of them.

Current price: $18.22
Potential upside: $22
Potential downside: $8

Salesforce.com (CRM)

Cloud computing stocks like Salesforce.com (NYSE: CRM) are the latest cult hit. CRM has been on an upward march for the past two years, gaining almost 108% in the past 12 months alone as takeover rumors buoyed the stock. The company offers a great service, but is unspeakably overvalued at 261 times trailing earnings.

How long can this cloud remain in the sky? I can’t say exactly, but the potential downside in this stock is incredible. A couple of bad earnings misses and the stock could lose 75% of its value over time as people cash in. The bulls argue CRM did miss during the last quarter and still went up. Bears argue what goes up must come down. Count me in as a non-trading bear. This is a silly investment given the risk/reward ratio.

Current price: $143.85
Potential upside: $155-$160
Potential downside: $35-$40