Momentum Is Great—If You Are on the Right End

By George Leong for Investment Contrarians

Apple Inc. AAPL finally broke below $400.00 last Thursday, an occurrence that I recently discussed in Investment Contrarians. As I said, the short term will generate volatility for the stock, but I continue to believe there is still hope the company can turn around going forward.

The problem with a momentum company like Apple is that with its rapid rise in share price to over $700.00, there’s immense risk for investor mistakes to occur if the company does not consistently deliver. And I’m not talking about delivering just average results; momentum companies such as Apple have to deliver exceptional results to the market and please investors.

In the case of Apple, soft growth over the last several quarters has proved devastating to the stock and can cause investor mistakes.

After beating Thomson Financial earnings-per-share (EPS) estimates by 22.5% in the fiscal 2012 second quarter, Apple came back and offered up three straight dismal quarters in which the company fell short on earnings in two of the three quarters and barely beat in the most recent. Ignoring these falls inevitably led to investor mistakes, as demonstrated by the share price.

The same is said for the overall stock market. Traders gave investors strong gains in the first quarter, but that has not been the case in April, as global growth concerns are surfacing. The aftermath has been selling pressure and the greater likelihood of more selling down the road.

The two cases of Apple and the overall stock market demonstrate the need to be careful with momentum stocks to avoid potential investor mistakes.

The reality is that once the market euphoria fades, the risk of a sell-off increases, which leads to investor mistakes and major losses. This is why I have been suggesting that you take profits as the market edges higher. The sustainability of the gains was clearly an issue, in my view.

Another big momentum stock that may be vulnerable to some selling is Internet bellwether Google Inc. GOOG. The stock is off from its high but still trades at nearly $800.00. Google is one bad report away from a sell-off and, given the current price, it wouldn’t be pretty. Just take a look back at Apple.

In the case of Google, while revenues are estimated to rise 40.2% in 2013, according to Thomson Financial, 2014 is predicted to see Google grow its revenues by a mere 15.6%. While the growth is still decent, the market will want to see more, and this could lead to investor mistakes.

Google, in fact, has seen its earnings’ surprises fall. In the first quarter of 2012, the company beat the Thomson Financial consensus EPS by a mere 4.5%, followed by 0.8% in the second quarter, and an earnings shortfall of 15.2% in the third-quarter earnings season. The fourth quarter saw a marginal rebound in earnings growth but, at 1.36%, it was not earth-shattering and could lead to investor mistakes down the road.

Another major momentum play that you need to be cautious about is priceline.com Incorporated PCLN.

With this slowing, you need to be careful when looking at momentum plays—whether it’s a stock, a commodity, or an index—in order to minimize investor mistakes.

On the other side of the ledger, an intriguing momentum play is Netflix, Inc. NFLX, which has beaten the Thomson Financial consensus EPS by an average of 154% over the last four quarters, which is exceptional and supports the stock’s surging price. But again, signs of slowing will likely crush the stock and result in investor mistakes.

This Article Momentum Is Great—If You Are on the Right End was originally published at Investment Contrarians