While they remain popular targets of short sellers, despite recent market weakness many high-flying consumer and technology stocks have continued to mount upon triple-digit P/E ratios. Lululemon (NASDAQ:LULU), Salesforce (NYSE:CRM), Panera Bread (NASDAQ:PNRA), Green Mountain Coffee Roasters (NASDAQ:GMCR) and VMware (NYSE:VMW) all garner valuations that would make legendary value investor Benjamin Graham run for the hills. My failed attempts to short Chipotle Mexican Grill (NYSE:CMG) in 2010 taught me the following five reasons to avoid shorting growth stocks.
- Momentum is a powerful thing: Growth can often continue beyond well reasoned calculation. Analysts are known for notoriously underestimating earnings for Apple (NASDAQ:AAPL), the greatest growth stock of a generation. Even companies with a more localized focus can grow beyond expected boundaries set by prior trends.
- High growth premiums in a low growth environment: Organic sales growth is hard to come by for in today's economy. The few companies able to integrate successfully with a more restricted U.S. consumer have investors from all corners chasing their shares.
- Interest rates remain at zero: Incentives to save are still non-existent aside from waiting for lower asset prices. Investors therefore have reason to overpay for a stock today that at some point down the line appears sure to appreciate.
- Long term USD trend remains down: Largely due to repeated fiscal measures but also to worldwide demographics shifting in favor of emerging markets, U.S. Dollar rallies have been relegated to brief shocks for the last decade. Waiting for better prices seems less and less appealing to growth stock investors.
- Better to chase dying dinosaurs: Growth is a powerful thing. So is downward momentum, both in terms of technical stock trading and fundamental business trends. The stock market is currently littered with high-priced names facing negative growth and piling up losses. Dine Equity (NYSE:DIN) and MGM Resorts (NYSE:MGM) come to mind.
Failing to factor in holding periods of buyers can be a downfall in short selling. Don't underestimate those high-flyers!