Trouble when trading high growth stocks (OPEN)

avatar By: IS
Date posted: 11.19.2010 (5:00 am) | Write a Comment  (2 Comments)

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If you live in the US or have been on a trip to the US in recent weeks, chances are that you booked a dinner reservation on the internet through Open Table. It’s a simple concept really. Open Table is the “Expedia” of restaurants. It will help match those looking for a free table and restaurants with tables to serve. Both parties like the convenience and Open Table gets a small cut in exchange for the service (generally 1$). The service has gained popularity and while the concept is simple, it would certainly be a big challenge for a competitor to compete on a National level. Why? It becomes difficult to only serve a few dozen or a few hundred restaurants when you are competing with OpenTable which serves over 14,000 restaurants and it becomes a much bigger challenge.

Because of the simple but brilliant concept, Open Table has been on a tear and sales continue to grow. That has led the stock to jump by almost 200% this year alone as it now commands a P/E ratio over 100… At that level, it starts to become a bit of an exaggeration and I liked the point made by hedge fund manager Whitney Tilson as he explained why he was shorting the stock .  The stock is even trading at 18 times sales! It’s not that the company has bad management or a bad business model but simply that it becomes difficult to see how Open Table could ever justify such a valuation. Now I did say that I liked the argument but since I did have problems going short Baidu in 2009 when it was flying (still is in some ways but not as much).

Bubbles…

In a way, it becomes similar to trading a bubble. Even if you are convinced that a valuation is unrealistic, it can be very difficult to keep the trade alive. In the case of Whitney Tilson, that is exactly what could be happening as he shorted OpenTable a few days before the company announced earnings… and when those earnings hit, the stock jumped even higher…. Now we do not know if Mr Tilson eventually decided to exit his position but I’m guessing he didn’t.

Shorting a bubble

Why did he not? Because he knew what he was doing and probably assumed that the trade would go against him for a little bit of time. There is almost no way of predicting the moment when a stock that has been going up for what seems like an endless amount of time will land back on earth. Trying to guess that exact moment will probably mean that you will miss the opportunity. I think that the only way to do such a trade is to do it while expecting to lose early. That is, in such a trade I would personally set the stop loss further away than in a regular trade. Yes, that does mean the loss could end up being bigger but it at least gives you a chance at a winning trade.

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2 Comments

  1. avatar

    [...] to determine if there is truly a bubble and even more of a challenge to time the possible collapse (talk to any Open Table investor). But I would advise against blindly buying all of these big [...]

  2. avatar

    [...] tend to go on further and for longer than anyone could expect. Stocks like Netflix (NFLX) and OpenTable (OPEN) have been shorted massively in recent months without success. Those who considered the stocks [...]

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