3 Short-Worthy Stocks That Deserved To Be Part Of The Recent Market Sell-Off

Includes: LNKD, LULU, NFLX
by: Convex Strategies

When the tide rises, it takes every boat up. When it sinks, however, so does every boat.

While the market isn't quite as simple, generally stocks will move in the same direction all at once. How far the movements will be, the long term strength of the company will determine the different performances of the stock.

Here are three stocks that were rightfully sold off recently:

Lululemon (NASDAQ:LULU): Trading at $64 before the brunt of the market weakness hit, Lulu needed a dose of reality. The long case is generally based on the idea that people will pay for high quality yoga pants, and that this market is large enough and has plenty of maturing so that Lulu can sustain 25% annual growth for the years to come. After growing 60% annually for the last five years, it's highly unlikely that Lulu continues that growth. Rarely (almost never) do companies grow more than 20% for a decade straight, and any sign of earnings weakness or lower guidance will pop the expectations.

While Lulu has a relatively strong balance sheet and good margins, it's trading at 7.6 times sales, and at 50 times trailing earnings. That simply cannot be justified unless its expected growth rate keeps up at an unrelenting pace. Additionally, the luxury-clothing industry is low barrier to entry, and Lulu's brand will be the trend until women fall in love with the next new item. Lulu is a decent company with outrageous expectations, and is still a decent short.

Netflix (NASDAQ:NFLX): Off nearly $70.00 since the broader market woes began, Netflix's eventual return to earth was simply inevitable. The top line growth (revenue) for Netflix over the last several years has been impressive, but the stock has far exceeded the true value of the company, as is typical with high flying growth stocks.

Now that Netflix's subscriber growth is reaching maturity, they need to begin ramping up prices for their services to significantly grow their earnings. Netflix did in fact announce a 60% increase on one of their service options. Price increases going forward, in addition to the growth, or even retention of their customers will be very difficult going forward.

Competition from Coinstar's (NASDAQ:CSTR) RedBox, Apple's (NASDAQ:AAPL) Apple TV, or even Amazon's (NASDAQ:AMZN) movie streaming service is fierce, and will severely cut into margins. While Netflix remains the best of the bunch for now in terms of movie rentals, its ability to grow as much as 32% (as projected) is highly unlikely, especially in a highly competitive field.

LinkedIn (NYSE:LNKD): LNKD is off $25 from the $105 it saw only a few weeks ago. Yes, the growth prospects for LinkedIn are exciting, and I expect LinkedIn's business to do relatively well over the next decade or so. The frantic buying seen on its IPO day however, is a clear example of how easily the share price of a company can exceed its intrinsic value.

LNKD is expected to grow 3,700% next year, and an average of about 86% per year over the next five. One thing is fairly certain: LinkedIn's earnings and revenues will grow, likely very quickly. What is unlikely, however, is that LinkedIn will casually meet investor expectations over the long, or even intermediate term. As is the case with stocks that have share prices that look like LNKD, the company will typically grow earnings at a solid rate, but the price to earnings multiple will revert back to a mean much closer to that of the broader market.

The investor psychology in LNKD stems from an idea that an investment will lead to quick gains in share price, not that the company will enjoy solid, realistic growth over the coming decades. Unfortunately for shorts, this psychology can last much longer than they can pay to keep their positions open, so LNKD is a tough short unless you have a large amount of capital to work with.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.