Published September 05, 2012
Yelp shares showed last week how dangerous it can be to invest with the crowd.
It seemed like a no-brainer that Yelp would follow the lead of Facebook (NASDAQ:FB) and Groupon (GRPN) two prominent media stocks that sunk when insiders were first permitted to start selling shares in the recent IPO.
Yet it’s the no-brainers in the investing world that are often the most dangerous.
There was such popular sentiment against Yelp (YELP) that the stock attracted 21% short interest by mid-August. That is, more than a fifth of the stock in circulation was borrowed, in anticipation that it could be bought back later for a profit.
No one stopped to think about how popular a trade it had become, and what would happen if Yelp bucked the precedent and none of its insiders sold at their first opportunity.
When it became clear that Yelp insiders had no immediate plans to sell en masse, the shorts scrambled. They had little choice but to buy back the stock and cover their positions at a loss.
The short covering caused the stock to rise more than 22% in a single day, and a lot of pain for the market participants that bet against it.
The lesson? Be very cautious any time the crowd either loves or hates a stock with a passion.
Even Apple (AAPL), the largest-cap stock in the market and one of the biggest stocks influencing investment returns this year, becomes more dangerous once investors think that buying it is nearly foolproof, says Robert Gay, manager of the Earnings Surprise and Luxury Linerinvestment models at Covestor.
"There’s no question that Apple has left the rest of the tech industry and most of the market in the dust this year,” Gay says. "But it’s now a huge holding of too many large-cap funds. It makes sense to start diversifying away from it very soon, especially since the company’s costs are now rising.”
Instead, Gay suggests replacing some Apple exposure with depressed tech stocks that have less cyclical sensitivity.
Investors punished Diebold last month after a delay in orders for voting machines in Brazil caused the company to reduce sales and earnings forecasts.
Yet Gay notes that Diebold’s sales growth is its highest since 2008. Operating costs are falling, cash flows are rising and the company continues to buy back shares. It also offers a 3.4% dividend yield, and has a history of increasing annual dividends.
“You likely want to move into this kind of stock right now, given its strong fundamentals,” Gay said. “It’s the rare type of value opportunity that has both a depressed valuation and accelerating cash flow.”
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