By Frank Curzio, editor, Small Stock Specialist
Friday, July 27, 2012
High-flying growth stocks are in a tailspin.
Shares of online movie-rental chain Netflix and footwear company Deckers Outdoor are down 40% over the past six months. Chipotle Mexican Grill is down 25% since last Friday. Health care services provider WebMD is 60% off its 52-week high. And the single-cup coffee pioneer Green Mountain Coffee Roasters has shed 75% of its value since March.
All of these growth stocks have one thing in common…
Since the beginning of the year, their earnings momentum has slowed. Each one has reported dismal quarterly results… and then fallen like a rock.
I mention this today because one of the biggest growth sectors of the past five years is starting to breakdown. These stocks are down about 15% in the past 45 days. And like most of the companies above, more pain lies ahead…
The sector I’m talking about is gaming.
Last month, I warned readers that casino operators like Las Vegas Sands (LVS) and Wynn Resorts (WYNN) could see huge declines in their stock prices. Thus far, this trend is playing out like I expected.
Las Vegas Sands and Wynn generate more than 50% of their revenue from Macau. This tiny island on the southern coast of China is the gaming capital of the world. And it’s the only place in China where gambling is legal.
In June, Macau’s monthly revenue grew 12%. That may seem like a big number. But it’s the slowest growth rate in three years – half what it was in 2011.
This has taken a toll on casino operators’ earnings. In the past few days, Las Vegas Sands and Wynn reported dismal results… missing estimates by a mile (a direct result of the slowdown in Asia). International Game Technology (IGT), the world’s largest supplier of gaming equipment, also disappointed analysts. It released its results Tuesday evening. On Wednesday, shares collapsed 20%.
Looking at the numbers, Las Vegas Sands and Wynn seem like great values after the selloff. The stocks are trading at roughly 13 times forward earnings… down from more than 20 times earnings in 2011. They also generate billions in free cash flow, which management says will be used to buy back stock.
But the estimates are based on these companies growing earnings at least 15%-20% next year. I see little chance of this happening… China’s GDP sits at a three-year low. This means the country’s wealthiest consumers – Macau’s biggest revenue driver – will likely spend less and less money gambling. So Macau’s monthly growth rate will continue to slow…
Throughout my career, the biggest mistake I’ve seen investors make is trying to catch a bottom in high-flying growth stocks. In fact, some of the best hedge-fund managers in the world are down huge after investing in Netflix and WebMD earlier this year. These companies also looked like bargains following their early selloffs. But they turned out to be value traps.
Avoid gaming stocks at all costs. Most analysts are still super-bullish on the gaming sector. About 90% of analysts rate Las Vegas Sands a “buy,” and 70% rate Wynn a “buy.” But you should avoid the sector. Unless China sees a massive short-term turnaround, there is little chance these companies can hit their inflated earnings estimates in the quarters ahead.