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Annie's, Inc., (BNNY) sells natural and organic food products. This company has been in business for a number of years, but it just went public in 2012. It recently reported adjusted earnings of 12 cents per share for the first quarter of fiscal year 2013. Considering that the company posted 12 cents per share in the same period last year, these results seem uninspiring to say the least, especially for a stock that trades for over $40 per share. A company that sports a price to earnings ratio of about 50, probably won't be able to report flat or nearly flat earnings for too long without the stock dropping in value. But a lack of meaningful earnings growth in the recent quarter is not the only issue. Below, we will take a closer look at some reasons why investors might want to follow the lead of other major shareholder(s), and consider taking profits, while the valuation remains at very lofty levels.

Annie's shares have performed exceptionally well since the IPO in March, but almost nothing lasts forever. As the saying goes, "past performance is NOT an indication of future results." In fact, a number of IPOs in the last several months performed well, and it was only later that the stocks fell sharply. There are numerous examples of stocks that went up for a while, and either shortly thereafter, or many months thereafter, fell precipitously. This list includes Facebook (FB), Groupon (GRPN), Zynga (ZNGA) and many others. A common factor that seemed to create a major decline in most of these stocks was the expiration of the lock-up period. IPO lock-ups restrict insiders from selling shares until a certain time period which is often 90 to 180 days after the IPO. If Annie's follows a similar path, that could spell trouble for the shares because the company just announced an early end to the lock-up period.

The selling of additional shares creates a major new supply of stock, right around the time when "IPO Fever" is waning. That combination can often only be answered with a lower stock price. The dynamic of new supply and relatively similar or fixed demand can result in lower prices just days after a lock-up expires, but sometimes it takes longer for it to take effect. When a stock loses "support" and breaks below a moving average or psychological price target, it usually triggers even more selling and by that time investors who are still holding on have lost out on a chance to sell at much higher prices. Those that used the lofty share price to sell are richer for it.

One seemingly sophisticated insider selling shares at Annie's Inc. is the Chairman, Molly Ashby. According to her bio, she worked for investment banking firm J. P. Morgan (JPM) for about 16 years. This means she is possibly far more savvy when it comes to selling stocks than the general investing public. What some investors might not realize is that she or companies she controls have been the major beneficiary from the proceeds generated by Annie's IPO, and the subsequent secondary offering. There is a big difference for investors when an IPO is used mostly to raise funds for the company that are used to grow, rather than when an IPO is used primarily to personally enrich company executives or companies they control. Recently, the company announced the sale of 3.2 million shares, but it was existing shareholders like her that received the proceeds. The shares were sold at about $39.25 each which resulted in another major cashing out of shares by insider(s) to the tune of about $125.6 million. If you add that up with the shares insiders sold during the IPO, it totals about $200 million worth of shares sold by insiders in 2012 alone. This is a huge statement considering this company has a current market capitalization of about $696 million. It's also very notable because of who is doing the selling. With about 16 years of experience at J.P. Morgan, Molly Ashby does not appear to be your average seller, and the amount of stock being sold so quickly after the IPO is also a potential warning sign for investors to consider.

I can see a number of reasons why insiders appear to be rushing to cash out of this stock, and the biggest one is valuation. This stock is trading at about 50 times earnings, which is nosebleed territory for many investors. When high PE multiple stocks breakdown, the losses can be stunning for investors. Facebook, Zynga, Groupon, were all high PE multiple stock that saw insider selling before those stocks plunged in value. In the food industry, Chipotle Mexican Grill (CMG) shares also recently plunged which reminded investors of the big risks of paying too much for a stock. As Jim Cramer recently said, "When a growth stock loses momentum, there's no telling how far it can fall," and that is exactly what has happened to so many IPO growth stocks this year.

You can't blame a sophisticated insider with investment experience like Annie's Chairman, for selling many tens of millions of dollars worth of stock, when it is trading at such lofty levels. Aside from major insider selling, another reason investors should consider taking profits in Annie's now is because the barriers to entry for the products sold by the company are very low. For example, it's relatively easy to have a contract manufacturer stamp out packages of macaroni and cheese with the word "organic" on it. There are many smart people in the food business, and when they see that marketing to health-conscious consumers can lead to a 50 times PE multiple, there will be much more competition in the future. Over time, the premium given to "health" food companies will moderate as competition increases and the novelty wears off. This can lead to PE multiple compression, because investors are no longer willing to pay such a rich multiple on earnings. When multiple compression occurs, a stock can drop in value even as earnings are growing.

There are numerous other reasons why caution is warranted with Annie's shares, which are discussed in another article. The bottom line is that when you see sophisticated insiders like Annie's Chairman selling shares in a very big way, that is often a clue for other savvy investors to do the same. I strongly believe that following insiders by selling shares will be a very smart move.

I liken many of the recent IPOs to a great party, it can be fantastic fun but only if you know when to arrive and when to leave. Those who stay too late at a party, often regret it shortly thereafter - just as shareholders of Groupon, Zynga and other formerly hot IPOs have painfully learned. When the party organizer "leaves" in a big way, and the punch bowl might be taken away soon, it's often a strong sign that the party might not last much longer.

Annie's Inc. Data From Yahoo Finance:

  • Recent Share Price: $43
  • 52-Week Range: $31 to $45
  • Current Year Earnings Estimate: 82 cents per share
  • P/E Ratio: about 50 times earnings

No guarantees or representations are made. Please consult a financial advisor before investing.

Source: Annie's Stretched Valuation And Heavy Insider Selling Are Red Flags