8 Cult Stocks to Avoid in 2011

by: Michael Shulman

I love writing about cult stocks, I get the most interesting emails- truly illuminating about their authors. When I “attack” cult stocks I get emails ranging from those calling me a sub-human to suggesting I do things on behalf of foreign governments ranging from Russia to Mars. My email has been boring lately so it is time to write about the cult stocks of 2011.

Do not confuse my negative attitudes about the stocks as negative attitudes about the companies. Most cult stocks belong to very fine companies. But it is hard to justify a P/E of 130 on a stock growing less than 10% a year when Apple (NASDAQ:AAPL) has a P/E of roughly 20-22 and doubled in size during the thirty months of the Great Recession.

Here is a sampling of some of my favorite cult stocks you many want to avoid if you are an investor or longer term trader. The estimates on potential stock prices are all mine and based on historical trends and data of other companies in their market segment, not a Ouija board. I am not suggesting you short them, a truck that is out of gas can still run you over if there are fumes left in the tank. Just be aware how overextended these stocks are based on underlying business fundamentals.

Baidu (NASDAQ:BIDU): The next Google (NASDAQ:GOOG), right? One point three billion Chinese searching for stuff all day long, right? A company loved by the Politburo, they censor anything and everything they are asked to censor, right? C’mon, get real. Baidu is a great brand in China. End of story. So if you believe China is going to slow down or blow – I do and more importantly, legendary short sellers Jim Chanos and Mark Hart do as well – Baidu will blow with it. And with a multiple of 89 and a market cap of $37 billion, there is a lot to blow up. What is the potential reward versus the risk? The stock is $115, a year ago it was $41. I see an upside of $150 versus a downside of $40.

Chipotle (NYSE:CMG): My twin sons’ addiction to CMG food is waning, although that may be due to the location of their colleges; in the middle of nowhere upstate New York, and in Scotland. It was, however, the first place they asked to stop when they got off the plane for Christmas break. The company has excellent management and is in good shape, masking slow growth in same store sales with continuing expansion financed with free cash and stealth price increases. The question is, how long can they keep this up? Bulls argue they can lock in very low cost leases due to commercial real estate depression, bears argue their growth and therefore their multiple is unsustainable. Investors really face a limited upside and harsh downside if they miss in earnings, the risk/reward ratio is simply not on the bulls’ side. The current P/E is 43, the stock is at $263, a year ago it was $94, I see the upside is $265-$300, the downside is $100. But I do love their vegetarian burrito bowls. No cheese please.

Dendreon (NASDAQ:DNDN): Dendreon is a cult stock with a cult following. I made my bones predicting it would get an FDA panel approval for a new treatment and the FDA staff would overturn that approval. I was right. Two years later, in 2010 the company received approval for Provenge, a treatment for advanced (terminal) prostate cancer that costs $100,000 and change and, on average, extends life slightly more than four months. In the coming weeks, CMS, the agency that approves or disapproves products for reimbursement by Medicare, is expected to decide whether Provenge will make the list and under what conditions. The stock is in the mid thirties and the decision is a potential twenty point mover either way, as private insurers almost always follow Medicare guidelines. I expect an approval with very tough guidelines and this could hit the stock. The stock is $58, was $26 a year ago. There is no E so there is no P/E; the upside is $70 and change, the downside $15 and change. That being said, Dendreon's Provenge treatment will save lives and the underlying technology may be extensible to cancers other than that of the prostate.

Harley Davidson (NYSE:HOG): I believe HOG was the most shorted stock in the U.S. in 2009 -- or was it 2010? All to no avail – the cultists pushed the stock up. The shorts (including yours truly back then) thought the company had serious problems with its balance sheet. It was borrowing money at 15% from Warren Buffett, who only trusted them enough to loan them money for a year, and then it may have been the first company to line up and receive funding under TALF. HOG still does have enormous long term debt and pension liabilities greater than $5 billion. I used to think HOG would have to re-organize in bankruptcy – that is no longer the case to my mind – but the current stock price is ridiculous. Retail sales declined 7.7% in Q3 compared to 2009. Yes, their business got considerably worse, and their profits were based in part on success with their finance unit that may not be sustainable. Bottom line: This $37 stock was $21 a year ago and is worth, maybe, $10-$12 if valued like a car company. Probably less. I would give you the P/E but in the past year there has been no E, the past quarter was not bad. I see the upside as quite limited – maybe $42, the downside $12-$15. Great bikes, though. Still the best.

Lululemon Athletica (NASDAQ:LULU): Where I live the Lululemon store is noticeable for the number of youngish men who sit across the street sipping coffee and watching the women enter the store, many of them physically capable of completely thrashing, with one hand, said oglers. A company still growing and still spitting out profits, it is not growing fast enough, or evenly enough, to justify a P/E of 50. I believe familiarity, not numbers, is keeping the stock up -- female analysts that work out and male analysts with spouses and friends who work out are very familiar with LULU. That being said, how many tangerine workout leotards does the average female jock really need? The upside for this $75 stock, which was $26 a year ago, is maybe $90 – the downside $30-$35.

Netflix (NASDAQ:NFLX): A great service, I am a subscriber, but a ridiculous stock with a P/E of 69. The stock is flying because a) lots of traders, investors and analysts use the service; b) it has entered the streaming business and this is hot; c) it is growing due to the increase in cocooning or stay at home entertaining that we are seeing due to the recession. NFLX is also rumored to be a takeover target but this will not happen at this valuation. No matter – one bad anything and boom, the stock gets cut by a third to a half. The stock is around $207, it was just $49 twelve months ago. The upside is limited – maybe $250, the downside is that yearly low, $49.

Open Table (NASDAQ:OPEN): Terrific service, I just used my first $50 Open Table gift certificate (and that also means it is time to go on a diet). That being said, companies with $4 million in quarterly earnings should not command a market cap of $1.6 billion. As with Netflix, it's a cult stock because so many people use and like using Open Table, customers and restaurant managers. A day of reckoning is coming though. Growth must slow simply because they already have so many restaurants, and people who eat out regularly such as myself, in the bag. One negative catalyst and the stock could lose 50%-75% of its value and still trade at a multiple higher than most service companies. The stock is around $83, the upside is $100-$110, the downside, in my humble opinion, is around its price a year ago, $25.

Pfizer (NYSE:PFE): Strictly speaking, Pfizer was a cult stock – the most owned stock in America – and is still highly favored among many investors due to its history, its excessive dividend as well as most analyst's opinions about the looming expiration of Lipitor: "They will figure it out.” As the writer of a short side service, I love that kind of analytical precision. Lipitor, an $11-$12 billion dollar drug (that is Billion with a B), comes off patent in the U.S. in November. Pfizer chose the worst possible partner to make the authorized generic, Ranbaxy. Teva (NYSE:TEVA) has already introduced generic Lipitor in Canada. Within a year ChangeWave and other surveys show Pfizer could lose up to 75%-80% of that revenue. There are no meaningful replacements in the product pipeline, the replacement drug failed in trial several years ago. Also, the cost cutting PFE is currently using to sustain earnings is unsustainable, as is the dividend, now at 4.5%. It could be cut in 2012. Projecting the fall of Lipitor sales into 2012 and 2013 earnings, the stock is worth $8 (my estimate), not $17 and change.

Salesforce.com (NYSE:CRM): This company has broken the heart of short sellers for years. A great service, great company, unspeakably overvalued – 245 times trailing earnings. So was Microsoft for more than a decade. But the day is coming when “the cloud”, the recession and the force of the market rein in that valuation. The story for traders is simple – what is the upside potential for a company with growth but a forward P/E of 180 (my estimate)? The downside is incredible: A bad miss and the stock could lost 75% of its value over time as people cash in. Bulls argue CRM did miss during the last quarter and still went up. Bears argue what goes up must come down. Takeover rumors have also buoyed the stock – rumors, that is all. Count me in as a non-trading bear. The stock is at $151, a year go it was $60, upside may be $190, downside is that $60 number.

Disclosure: I am not short any of these stocks, I do not own puts on these stocks, and I do not recommend shorting them in my service Michael Shulman’s Short Side Trader, except Pfizer and I have recommended puts for January 2012.