Green Mountain Coffee shares due for a pullback

• Ian Wyatt
• On 12:00 am EDT, Wednesday September 9, 2009

During the biggest economic downturn and stock market collapse since the Great Depression, Green Mountain Coffee Roasters (NasdaqGS:GMCR - News) has by all accounts been having its best year yet.

Green Mountain is firing on all cylinders, and in the most recent quarter reported a 61 percent increase in revenues and 123 percent increase in profits. So impressive is the growth that "Fortune Magazine" recently named the company 11th on its annual list of the fastest-growing companies.

Investors in the Waterbury-based coffee company have seen the stock jump 136 percent year-to-date, and a stunning 1,224 percent over the past five years, from $4.53 to $60. The rise in the company's stock follows impressive financial performance coupled with new relationships with Mr. Coffee and Walmart, and an acquisition of Tully's Coffee on the West Coast.

The company is an outstanding example of a small-cap stock that was unknown for years, and has recently emerged as a well-known, high-growth success story. Both institutional and individual investors have been buying up shares, as the media spreads the gospel of coffee from the Green Mountain State.

However, the company's past success and the dramatic rise in share price shouldn't be reason to buy shares of Green Mountain today. Investors must carefully consider the future prospects for growth, and the valuation before buying the stock. Potential shareholders should give credence to the common phrase in every investment prospectus, "Past performance does not guarantee future results."

While recent years have proven to be an outstanding time to be invested in this stock, there are signs that the soaring share price will likely take a breather, at least in the near-term.

After shares of Green Mountain surged in recent years, the company elected to split the stock. While stock splits are often viewed positively, it is essentially a nonevent. The only outcome of a stock split is to decrease the share price to make the stock more attractive to potential investors.

For example, in June, Green Mountain was trading at $90 per share. If an investor owned 50 shares, the investment was worth $4,500. The company then split the stock, and issued every shareholder three shares for every two shares they owned. The share price was adjusted down by one-third, to $60 per share. The investor now owns 75 shares at $60, but their investment is still worth the same $4,500. While the numbers have changed, the investment or value has not.

In July, Green Mountain announced plans to raise $321.4 million through the sale of new shares to the public at a price of $67.25 per share, known as a stock offering. The proposed offering will increase the number of shares by 13 percent, and therefore dilute existing shareholders and reduce future earnings-per-share (EPS). With shares currently trading below the proposed offering price, which was scheduled to close Aug. 12, it is likely that the offering price will be reduced. The stock split may have been completed in advance of the planned equity financing in order to attract more investors with a lower share price.

Since the beginning of the year, there have been no insider purchases of Green Mountain shares. Insiders, the officers and directors of the company, have instead been selling shares of stock as the price has risen. Already this year, insiders have executed options and sold 703,152 shares for $52.9 million. Even more impressive is sales of shares by insiders in the past two years has reached nearly $200 million.

Green Mountain founder Robert Stiller currently owns nearly four million shares of stock valued at $239 million. But he is the exception among the management team, which holds little stock in the company. President and CEO Lawrence Blanford owns just 4,450 shares of stock, according to filings with the Securities and Exchange Commission (SEC).

Officers and directors of a public company are often granted stock options as part of their compensation package, and sell shares in order to diversify their personal finances. However, the fact that there hasn't been a single purchase of Green Mountain shares by a company insider in either 2008 or 2009 may indicate that management believes shares are fully priced. Additionally, the planned equity offering similarly indicates that management believes now is a good time to sell the stock. This might be a case where management's actions speak louder than their words.

However, Wall Street is bullish on Green Mountain, which has become a favorite holding of small-cap and growth-oriented hedge funds and mutual funds, who have been buyers of the stock.

Investment bank research analysts expect a bright future for Green Mountain. For fiscal 2009 (ending Sept. 30), analysts expect sales to increase 60 percent and earnings-per-share (EPS) to nearly double to $1.13. And the outlook for 2010 is similarly impressive, with consensus estimates of a 48 percent increase in sales and 57 percent increase in EPS.

With new business initiatives under way, expectations are that the company will continue to grow at an impressive pace. Stocks are often valued on a price-to-earnings (PE) basis. Shares of Green Mountain currently trade at 53-times 2009 and 34-times 2010 EPS estimates, and at a multiple of two-times 2010 sales estimates of $1.18 billion.

Green Mountain shares command a healthy valuation compared with other stocks in the packaged and processed goods sector, which trades at just 15.5-times trailing earnings from the last 12 months. However, analysts and investors believe the higher PE multiple is justified, given the outstanding growth prospects for the company.

Green Mountain is the ultimate success story of a small-cap stock that started out small, grew rapidly, innovated, created jobs, and contributed to the local community along the way. Every investor should look to Green Mountain Coffee for lessons that can be applied to finding other small-cap stocks on the verge of hitting it big.

Despite warning signs that indicate that shares of Green Mountain are overpriced in the near-term, the company's future appears bright. And if Green Mountain is able to hit Wall Street's expectations, the stock should continue to rise in the long-term. But investors should know that the future growth of the company and appreciation of its shares are unlikely to mirror the very impressive past performance.

I encourage investors to wait for the equity financing to close, and look for a pullback in Green Mountain shares before buying this high flier.

This article was originally published in the Business Monday section of The Burlington Free Press on September 7, 2009.

Ian Wyatt is the founder of Business Financial Publishing and author of the upcoming book, "The Small-Cap Investor: Secrets to Winning Big with Small-Cap Stocks." You can learn more about his book at http://www.smallcapbook.com, read his blog at http://www.IanWyatt.com, and follow him on Twitter at @IanWyatt.

Buzz up!