Managing stocks trading around their 52-week highs can be tricky. While investing pros will tell you not to be greedy, when is holding a hot stock foolish and when is it a good investment decision? NYU Stern's Investment Analysis Group (IAG) faced this question when they decided to toss Crocs (CROX) - Get Report, and it's one that many investors face on a regular basis. What is it about a high-flying stock that can scare some investors away?
The Battle Meeting
The IAG is an undergraduate investment club that gets together every Friday night to talk stocks. Typically, a few members will present a stock to add to one of the group's portfolios ("All-Star" and "Initiative"), but on Oct. 12, the group's two
portfolio managers went head-to-head over Crocs, the makers of the eponymous popular plastic shoes.
Until this point, Crocs had made up around 13% of All-Star's holdings, and portfolio manager Neal Sangani (senior) wasn't ready to sell any time soon. However, Initiative's portfolio manager, Todd Tamagnini (senior), felt that Crocs had reached the point where it should be sold to lock in the group's
Enter the "battle meeting," where Sangani and Tamagnini had a chance to have it out over whether the stock should stay. Ultimately, IAG members decided that cashing out Crocs would be the best solution, but Sangani still feels the group should have stuck it out longer.
On his blog, Sangani wrote, "This is a company with an impressive, but short operating history, which creates sensitivity to near-term
earnings or projections. And of course, given the strength of its business, this is usually a company at the fearful, dreadful, absolutely and utterly terrifying level known to most as the '52-week high' ... When it comes to
growth, IAG usually screws up big."
Can the 52-week high really have that impact on young or new investors?
Rationale for Passing on Growth Plays
There are a few theories on both sides for why the IAG members would choose to pass on a growth play: the company really is a bad choice for the portfolio, new members don't have the background to make informed investing decisions, the cases weren't argued properly at the meeting, and so on.
It's important to remember that this kind of thinking isn't relegated to the halls of NYU -- it's part of a decision-making process plenty of investors go through when taking a look at a stock that's enjoying a high.
In terms of Crocs, during Tamagnini's sell pitch, the core of his thesis was that "there is a low barrier to entry." Tamagnini said, "Any footwear maker can start making a 'Crocs shoe.' In fact,
just did. The footwear industry is so
volatile with the trends that we're seeing
that we might see things go back to high-cost shoes in the next few years or so."
IAG member Jonathan Goto (sophomore), who voted against Crocs because he felt that it was over-hyped and ready to deflate, echoed a few of Tamagnini's points and offered his own take on growth-stock investing.
"I disagree with the notion that IAG has 'avoided' growth stocks, as Neal
Sangani likes to argue. At the same time, the market has a historical tendency to '
overvalue' growth, and stocks whose
valuations are based on ebullient expectations are prone to disappoint. Crocs, to me, is an interesting trade. It's got a lot of
short interest in it, and if it beats expectations, then sure, it'll pop. At the same time, the expectations that are built into giving Crocs a nearly $6 billion
market cap are so optimistic that I question their sustainability. I see low
and/or no barriers to entry into Crocs' market, and I question the soundness of putting Crocs into the portfolio. Neal didn't provide enough data to convince me that our potential upside outweighs the real
risk that Crocs will not perform to expectations. I wouldn't want to play this company
Fear of Heights?
Sangani feels that a big part of the Crocs decision was based on the fact that people are scared of growth stocks at a 52-week high. Sangani says: "I think a lot of the fear in stocks trading at highs has to do with the aftermath of the dot-com bust. I believe a lot of this fear was reflected in the market with the
several years ago.
"The effect is more evident with newer investors because they do not do the in-depth industry research that is necessary to put a stock price in context. They simply take high
multiples and low multiples at face value and believe it would be safer to simply bet on the lower multiple company and/or the company trading at a
52-week low rather than a
52-week high ."
While Sangani concedes that the potential for a big downside is a concern with Crocs, he points to research as his primary attraction to the stock. He sees the stock doubling its current share price.
Sangani explains: "I believe IAG has avoided growth stocks because there is a much higher burden of proof when communicating that a company deserves a high multiple rather than asking members to invest in a company with a low multiple. In the latter case, a presenter essentially succeeds by doing nothing; and it is up to the members to determine 'what's missing?' to reason why the company should be
discounted to its peers and not voted into the portfolio. However, in the case of a growth company, with a higher multiple like Crocs, a presenter needs to
that the multiple is well-deserved using relevant factors. The burden of proof here is higher too because the forward projections are for younger firms that do not have a long operating history."
Both sides appeared to agree on one thing, however -- that newer members often succumb to groupthink when voting on a new pick. Goto said, "One of the challenges that more experienced members have in IAG is to share insight with more novice members to give them some framework on which to base their votes. Without that framework, less experienced members really have no tendencies one way or another -- with respect to growth
value, 52-week highs
and/or lows -- and tend instead to vote with the most dominant voices in the room."
While growth stocks might require a higher "burden of proof," it shouldn't be forgotten that they can offer us quite a bit in exchange. Here are a few of the stocks (with
year-to-date performance) that Sangani says had an uphill battle at IAG meetings, when their share prices were each pretty close to 52-week highs:
- Google (GOOG) - Get Report: Up over 50%
- Chipotle Mexican Grill (CMG) - Get Report: Up over 135%
- Blue Nile (NILE) : Up around 110%
- CTrip.com (CTRP) - Get Report: Up over 80%
It's understandable why many feel like investing in a stock trading at a high is a bad idea (what goes up must come down, right?). But these four stocks help show that what goes up can sometimes
going up. Which side was right in the Crocs battle? As of November 1, Tamagnini and the sell camp (see
"Thursday's Winners & Losers").
If you want to learn how to get a step ahead of stocks trading at 52-week highs, check out " How to Trade 52-Week Highs."
Jonas Elmerraji is the founder and publisher of Growfolio.com, an online business magazine for young investors.