The first place to look for such victims is among high-flying stocks with very high price-earnings multiples, enough of a market cap to have retail investor interest, and niches in the market that are subject to question.
I recently did a screening for such shares, limited to those with a market cap of over $1 billion. I then examined each company that popped up, looking for arguments against their business models.
Most of the high-flyers are energy companies, mining companies and health care companies. These I find tough to play because they can easily justify investor love with a gusher, a new metals find or the excuse that the collapse was a “one-time event” and conviction next quarter will be different.
Technology is another matter. Moore's Law has a naturally deflationary character to it. This tends to break down the walls of advantage managements may claim. What is first made becomes a box, what is a box becomes software, and each stage provides entry points for competitors.
So here are some choices (I included a health care and operating company here just for fun) and my early line:
Fusion IO (FIO) – This is a cloud play, a maker of chip-based memory systems that can sit between a cloud's data center and its processing, much as computer chips themselves will have on-board cache memory. At $28.19 per share, however, they are sporting a PE of 139, with rapidly-expanding returns on equity and assets. But with just 27 cents per share of earnings expected by analysts this year, you're looking at a median PE of 101 based on forward earnings. Any hint of non-performance will hit FIO hard.
Aspen Technology (AZPN) – They make process optimization software, good for factories, for logistics, and for squeezing out costs generally. At $17.04/share, their PE is over 125, yet expenses often outrun revenues. Only one quarter in the last five was profitable at all. Makes one wonder why most rate this a buy, especially with a forward earnings estimate of 22 cents, which still yields a forward PE of 84. Management has tried to warn that 2012 estimates are too high.Maybe it's time someone listened.
AthenaHealth (ATHN) – Technically a health play, but really a tech play. They have gone from a niche in helping doctors to get paid into SaaS-bsaed Electronic Medical Records (EMRs), hoping for some of that sweet, sweet stimulus cash and a little cloud excitement. Plus if you're bullish on Bushes their CEO is Jonathan S., a first cousin to W (his dad is HW's kid brother Jonathan) The company's other co-founder is now part of the Obama Administration, so you're covered politically. But what's with this price of $54,65, a PE of 92? They are making money with accelerating revenues, but not a ton. Their 23 analysts expect earnings of 86 cents this year, which is still a forward PE of nearly 51. Any failure to execute and cloud becomes fog in a big hurry.
Hyatt Hotels (H) – What is a hotel chain doing with a PE of 102? You're looking at bouncy revenues and earnings, and while it is a cash flow machine the median estimate for 2012 earnings is 87 cents, a forward PE of 43. Bank of America recently upgraded them seeing them as much as a real estate play as an operator. Do they expect a huge profit upgrade from busting the unions? OK, they have new properties in China and Abu Dhabi. If you hear the words “global” and “recession” in a sentence, shorting H may bring a quick profit.
Amazon.com (AMZN) – This may be the most popular short here at Seeking Alpha. (I own some.) With its current price of $178, it's got a PE of 94, and it's bouncing around there for some time. Everyone knows the story here – ecommerce, cloud, Kindles – and everyone has an opinion. (Wait until Google's lawyers see how they stripped AdSense out of their Web browser.) Current estimates for 2012 earnings among 40 analysts is $2/share which still yields a forward PE of 85. Want to get in front of this freight train? Many do.
Rackspace (RAX) – I'm saving the best for last, not because I'm rooting against Rackspace, which is based in a former San Antonio shopping mall, but because I expect competition to hit them hard, soon. At $42/share you're looking at a PE of 89, with ginormous gross margins turning into 10 cents of earnings per dollar of revenue, pre-tax. There are currently 20 analysts for it estimating 53 cents on earnings this year, which still comes to a forward PE of 55. As the main sponsor of the OpenStack cloud software project, they get much love. But Amazon's API is still more popular, and their main business is web hosting, traditionally low-margin. Besides, they have a bullseye on their back as near-neighbor Dell Computer puts $1 billion into building its own cloud-based hosting network. It's like Rice watching Texas recruit football players – even if they had a down year last time you think they're going to keep losing? I went to Rice. I don't.
What are your favorite short plays for 2012?
Additional disclosure: Changed the headline. Y'all seem to see that as a real weakness with what I write for you, so I'm working on it.