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Momentum is wonderful, but it doesn’t last forever

Tribune-Review
| Tuesday, November 4, 2014 12:01 a.m

Let’s take a look at a few stocks that have been leaders of the pack this year.

For the 43 weeks through Oct. 31, these five stocks were the top performers in the Standard & Poor’s 500 Index:

• Keurig Green Mountain Inc., up 100 percent;

• Electronic Arts Inc., up 81 percent;

• Edwards Lifesciences Corp., up 80 percent;

• Mallinckrodt Plc, up 78 percent;

• Southwest Airlines Co., up 77 percent.

In my opinion, only one of these five is likely to beat the general market during the next 12 months. Hint: It’s the only one that flies planes.

Keurig Green Mountain

After dropping from more than $100 a share in 2011 to less than $20 in 2012, Keurig Green Mountain (GMCR) has staged a roaring comeback. From its 2012 low, it has risen more than 700 percent; this year, it has doubled. With more than 100 varieties of coffee and a hit single-cup brewing system, the company is doing very well.

A few years ago, I sold this stock short, in an ill-timed bet that it would decline. I underestimated the company then, and perhaps I am doing so again. Yet I believe that the stock will be at best a market performer in the next 12 months.

It sells for 37 times earnings, even though analysts project earnings growth of less than 10 percent for the fiscal year that ends in September 2015.

Electronic Arts

Over the years, I’ve recommended Electronic Arts (EA) a few times. Lately, however, I view it as pricey.

The company, with headquarters in Redwood City, Calif., is a leading maker of video games. Video games are a highly competitive field, and the tastes of the consumers — many of whom are teenage boys — change rapidly. The stock briefly exceeded $60 in 2004 and 2007, and then fell to a low of about $11 in 2012.

Given those facts, I wouldn’t jump on this stock at today’s price of $41. Better to be patient and grab it when it’s out of favor.

Edwards Lifesciences

Based in Irvine, Calif., Edwards Lifesciences (EW) makes a variety of cardiovascular products, most notably heart valves. Revenue is growing nicely, earnings even faster. Last year, the company reported a 44 percent return on stockholders’ equity, a superior number.

I expect that Edwards will continue to do well in 2015, but I think the stock, after this year’s surge, may lag. It sells for about 30 times estimated 2015 earnings, 5.7 times revenue and 6.3 times book value. If everything goes swimmingly, that will be no more than what Wall Street expects.

Mallinckrodt

When a large corporation spins off a division or subsidiary, the spinoff stock often does well. That happened this year with Mallinckrodt, a drug company based in Ireland that separated from Covidien in June 2013. The stock has marched from $45 to $92.

In the world of big drug companies, Mallinckrodt is comparatively small. It had $2.2 billion in sales in fiscal 2013, compared with $51.6 billion for Pfizer Inc. (PFE) and $44 billion for Merck & Co. (MRK). Mallinckrodt is best known for its painkillers. It is a leading provider of drugs based on opium and is a large manufacturer of acetaminophen.

The stock sells for 14 times analysts’ estimates of earnings for the fiscal year in progress. I think there are some gains still to come, but I believe the dramatic gains are past.

Southwest Airlines

Widely regarded as the best-run U.S. airline, Southwest Airlines (LUV) has benefited from industry consolidation (resulting in fewer planes per route and fuller planes) and from falling fuel prices. The latter trend has accelerated in recent weeks. Just as consumers are paying less at the gas pump, airlines are paying less for their jet fuel.

For these reasons, I figure Southwest will outperform the market during the next 12 months. Yet I like a couple of other airlines even better — Alaska Air Group Inc. (ALK), which I own for most of my clients, and Delta Air Lines Inc. (DAL), which I own for one client.

Perils of momentum

The last time I looked at a group of big intra-year gainers was in December 2013. I took a dim view of that bunch, too. It comprised Fannie Mae (FNMA), Freddie Mac (FMCC), Canadian Solar Inc. (CSIQ), Lannett Co. and SunPower Corp. (SPWR).

Lannett continued to soar, but the four other stocks faltered, with outright declines from Fannie Mae and Freddie Mac. Collectively, the five stocks underperformed the S&P by a point and a half from Dec. 17 through Oct. 31, 2014.

The moral: Momentum can be a very temporary thing.

John Dorfman is chairman of Dorfman Value Investments LLC in Boston. He can be reachedat jdorfman@dorfmanvalue.com.

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