Watching a momentum stock rocket higher can be thrilling. But if there’s one thing the dot-com collapse taught us, it’s that investing in a company simply because it’s gaining steam can also lead to disaster.
It appears investors haven’t learned, though…
The same speculative fervor is still active on Wall Street today – and the regulators have done little to curb investors’ blind enthusiasm.
The latest example is advanced fuel cell technology firm, Plug Power (PLUG).
Plug’s Abysmal Treatment of Shareholders
Our Chief Technology Analyst, Marty Biancuzzo, put Plug Power through his C.H.A.O.S. Meter in April.
It didn’t pass muster. As Marty said at the time, Plug is “an insanely volatile stock, with shaky fundamentals [and] a speculative energy technology that’s failed before.”
I think that’s an understatement.
Plug Power represents the purest form of wild, speculative frenzy with little more than a hope and a prayer for success.
Here’s what I mean…
Plug was trading for less than $1 in December 2013.
Then the company announced that it was bullish on its own prospects, and a handful of analysts decided to get behind the stock.
Other analysts called Plug’s bluff – proclaiming that the shares were worth half a buck, at best. But that didn’t stop many investors from riding the Plug express train higher.
Shares ended up soaring to $11.72 by March. We’re talking about a quadruple-digit percentage increase in just over three months – based on zero fundamental improvements.
Then things took a turn for the worse. (Shocker, I know.)
After hitting its March high, Plug almost immediately announced a secondary public offering of more than 22 million shares.
The offering was eventually priced at $5.50 per share – more than a 50% discount.
So the company did nothing to temper the market’s enthusiasm for the shares at $11.72. But it was more than happy to sell shares to the same investors at less than half the price.
Making matters worse, Plug has raised money two other times this year alone – once at $3 and the other time at $5.74. And in 2013, it raised close to $150 million on sales of barely $30 million.
To give you an idea of how much Plug raised relative to its sales, it would be like Apple raising $1 trillion in the market.
Shares are now trading at just over $4 per share – after dropping to $3.70 last week after it reported mediocre earnings.
It did provide an outlook that was bolstered by deals with Wal-Mart (WMT) and FedEx (FDX) to provide fuel cells. But both companies are buying the fuels cells to take advantage of federal tax credits for renewable energy. Eventually, those credits will disappear…
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Ultimately, Plug is doomed to fail. It’s obvious that the company is plenty satisfied with its shares trading for $3.
But for investors who got in at $11, well… they got screwed.
Now it’s time to ensure that the same thing doesn’t happen to you going forward…
Five Signs That You’re Dealing With “Roadkill”
Let’s review a few key things to keep in mind when investing in momentum stocks. If you see the following red flags, the stock is probably nothing more than “roadkill.”
- If the company has a poor history of making profits, then there’s likely a good reason for that.
- If a company is willing to raise money at a lower price than where the shares are trading, it’s because it can’t sell shares for the current price (or higher).
- If a company is willing to dilute investors three times in less than four months, it doesn’t really care about the price you paid – or shareholders, in general.
- If a company can justify raising money at $3, then that’s likely what it thinks shares are actually worth in the market.
- Finally, when you see a company announce a secondary offering, chances are good that it’s signaling a short-term exit price for traders and investors.
In the end, the fact that Plug was able to soar so high before crashing is a clear signal that most traders paid no attention to the fundamentals – or the previous capital raises.
Instead, they were only tuned in to the momentum and the hype spewed out by the talking heads – some of whom undoubtedly had something to gain from Plug’s rapid journey to $11.72.
Bottom line: Companies like Plug don’t deserve money or respect for the way they accessed the markets for capital. And it’s not the only company that’s guilty of this strategy. Be on the lookout for similar deadbeats in the market in the future.
Ahead of the tape,