At some point, every “cult stock” goes through a period in which investors recognize its overvaluation, causing the stock to fall. In some cases, however, this drop in price can present a worthy investment opportunity at a good value. After it cut guidance yet again, is Outerwall Inc (NASDAQ:OUTR) now a buy?
The cult explained
A “cult stock” is defined as having a large investor following despite somewhat unimpressive fundamentals. We have seen companies like LinkedIn, Tesla, and Workday, among others, fit in this category. These stocks continue to tick higher, often beyond reason, until the lowering of guidance or a change in perception sparks a drastic fall.
In the five years prior to August 2011, Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) soared 3,500% with explosive year-over-year growth of more than 100%. However, fears of lost patents, high inventories, and slowed growth pushed shares from more than $100 to less than $20.
Netflix, Inc. (NASDAQ:NFLX) had also seen an impressive rally in the years prior to August 2011, boasting 50% sales growth, but then it fell from $300 to less than $70 in just four months. Most notably, fears of slowed growth, margin decompression, and high content costs led to the decline.
The realization: This stock ain’t so bad after all
What’s funny about these cult stocks is that beneath their inflated valuations lie pretty solid companies. Therefore, in the case of companies that have followed the cult pattern (Netflix, Inc. (NASDAQ:NFLX), Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR), Questcor Pharmaceuticals, etc.) have also seen a period of realization, or post-fall gains.
Both Netflix, Inc. (NASDAQ:NFLX) and Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) now trade at pre-fall levels but with a different look. Today, Netflix, Inc. (NASDAQ:NFLX) and Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) are experiencing low-double-digit growth, and impressively, their margins have risen. These two companies have eased many of the concerns that led to their fall.
Seeking a second pop
Essentially, the cult-stock fall gives the fundamentals time to reflect on the stock. Then, stocks are more attractive from a valuation point of view. Netflix, Inc. (NASDAQ:NFLX) and Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR), valued at a respective 4.5 times sales and three times sales, are much cheaper than they were in 2011.
Now, for value investors, this post-cult space appears to be a good place to seek opportunity. In particular, Outerwall Inc (NASDAQ:OUTR) really sticks out to me.