As companies emerge from a rough stretch, their shares can quickly move back into favor with investors.
Trouble is, the rebounding share price can often overshoot the mark and move into overvalued territory, especially if there has been a massive short squeeze in play. Here are three fast-rising stocks that have rapidly moved from being undervalued to overvalued.
|Best Buy (NYSE:)|
| This beleaguered electronics retailer has seen its stock more than double this year as an extended period of quarterly profit shortfalls appeared to come to an end. |
Best Buy had been steadily losing traction as its prices were higher than online rivals such as Amazon (AMZN) and Wal-Mart (WMT). In response, Best Buy has been slashing prices, which has reduced gross margins but helped stabilize foot traffic.
To offset the lower gross profits, management has been radically paring overhead, including sales staff. Note that Best Buy's business model once depended on a knowledgeable and friendly sales staff. Fewer salespeople means a lot more standing around for consumers, waiting to get their questions answered (which has been my experience on recent occasions). At some point in such an environment, shopping online becomes the easier option.
More to the point, this stock’s rebound has eliminated any sense of this stock being a value play. Shares now trade for more than 10 times consensus fiscal 2014 earnings per share (EPS) of around $2.40.
What’s an appropriate earnings multiple for a retailer with limited growth prospects and ever-deepening competitive pricing pressures? “We believe that 8X is a reasonable multiple given our view of the company’s risk profile, EPS growth trajectory, and recent low-quality earnings,” said analysts at Citigroup, adding that they expect shares will fall to their $19 price target.
Analysts at Merrill Lynch said, “While cost reductions so far have been impressive and we believe there will be more to come, we think these initiatives will be insufficient to return earnings and cash flow to attractive levels in the next few years.” That view underpins an $11.50 price target, which is less than half of the current stock price.
|H&R Block (NYSE:)|
|Shares of this tax preparation service have risen more than 50% this year on hopes that the imminent major changes in health care stemming from the Affordable Care Act will make personal income taxes so complex that consumers will flock to H&R Block for help. |
But will that really be the case? After all, tax prep volumes for the season just ended were down 0.9% compared with a year earlier for H&R Block, mirroring pressures seen by Intuit (INTU). Additionally, in the past few years, this industry has evolved into a slowly growing, mature market.
What impact will the Affordable Care Act have? Well, there is sure to be some confusion around its implementation. Many consumers are likely to need help figuring out which health care subsidy they should receive, or what health care taxes they might owe.
Risks to Consider: As an upside risk, these stocks each has a short interest that is equivalent to at least two days' trading volume, and rising stock market could squeeze them higher.
Action to Take --> These bull market stocks appear to have been lifted by the sense that troubles in 2012 have been replaced by blue skies ahead in 2013 and beyond. Yet such a sunny view should invite caution, as the fundamentals underpinning each of these stocks’ gains appear to be on shaky ground.
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