3 momentum stocks to approach with caution

Which way are these picks headed?

By InvestorPlace Oct 28, 2011 9:35AM
By Jamie Dlugosch, InvestorPlace

Momentum stocks are fun to own when they are going up. Not so much on the way down. Imagine those poor investors who bought a stock like Netflix (NFLX) when it peaked above $300 per share. At about $80 per share now, NFLX is a shell of its former self.

Perhaps Netflix never was what some thought it might be: the king of the media content delivery hill. It turns out there are plenty of threats to the business that put Netflix's future very much in question. Momentum investors don't like questions. They expect fervent belief without doubt.

In some ways, momentum stocks are like cults (think Jim Jones). When things are going well, there are plenty of investors willing to drink the Kool-Aid.

Some say stocks like Apple (AAPL) and Google (GOOG) are cult stocks. They are not. While fanatics love both companies and their products, the market for both companies is perfectly rational. Pricing on a fundamental basis hardly resembles a crazy momentum stock.

Ultimately, the key to playing the momentum game is to keep a firm grip on reality by monitoring valuation from a fundamental perspective. It is OK to ride the wave of unfettered enthusiasm for the prospects of a momentum stock. The trick is to understand how fragile that momentum might be.

There appears to be a shift taking place in the market with respect to momentum stocks. You better be able to show investors the goods, or you will be punished. Here are three momentum stocks that still are flying high (and where they might be headed):

Chipotle Mexican Grill. This fast-food spinoff from McDonald's (MCD) continues to impress. Chipotle Mexican Grill (CMG) stock has been on a steady path higher since shares went public in 2006. Gains in the stock have been fueled by strong earnings growth.

The company reported earnings results last week that beat Wall Street expectations. Chipotle made $1.90 per share in the quarter ending Sept. 30. The average Wall Street estimate was $1.85 per share. The strong numbers were needed to support what has been a rip-roaring stock in 2011. CMG shares are up 55% so far this year. For the full year, 

Wall Street expects the company to make $6.82 per share. That number jumps 26% to $8.60 per share in 2012. At current prices, Chipotle trades for 49 times current earnings.

However, because the stock is so highly valued already, earnings beats are critical for Chipotle. There is simply little room for error. One misstep, and CMG could crumble.

Buffalo Wild Wings. Wing-slinging restaurant Buffalo Wild Wings (BWLD) looked to be clipped in July. Shares sank after growing impressively for most of 2011. BWLD looked ready to fall further heading into third-quarter earnings season. Fortunately, B-Dubs delivered the goods.

Last week, the company announced a profit of 61 cents per share in the period, beating the average Wall Street estimate of 59 cents. Revenues also were above expectations. The news sent the stock up about 5% after the report.

For now, things appear to be rolling for BWLD, but is it likely that such strong performance will continue? Higher commodity prices have the potential to reduce profit margins, and the NBA labor strife could negatively impact Buffalo Wild Wings, whose stores are plastered with TVs to draw in their large sports-fan customer base.

Wall Street expects Buffalo Wild Wings to make $2.66 per share in 2011, growing 22% to $3.24 per share in 2012, and BWLD trades for 24 times current-year estimated earnings. The company looks to be at a tipping point. I would be careful with BWLD.

Panera Bread. The big winner in the stock market Wednesday was Panera Bread (PNRA). Shares of the corner baker and sandwich shop were up 15% after the company reported strong results for the third quarter. Panera made a profit of 97 cents per share versus Wall Street estimates of 94 cents. More importantly, the company raised guidance for fiscal 2012 to a range of $5.38 to $5.48 per share.

That sort of growth in profits keeps this momentum stocks moving higher. Thus far, bets that PNRA growth will slow have been too early. When a momentum stock keeps impressing, shares will go up no matter the macro environment. And Panera is up a solid 31% so far this year.

Wall Street expects Panera to make $4.58 per share in 2011. Using the low end of new guidance for 2012 profits, growth for next year will be above 17%. At current prices, including Wednesday’s gains, Panera trades for 29 times current-year estimated earnings. As long as PNRA can continue to beat expectations and raise guidance, this momentum stock should continue to soar.

As of this writing, Jamie Dlugosch did not own a position in any of the aforementioned stocks.

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