Rick Aristotle Munarriz at TMF responded to my Green Mountain Coffee Roasters Inc. (GMCR) article with Let’s Ground Some Bears. Munarriz’s main arguments were; he’s had a Keurig brewer for two years so it’s not a fad, analysts are predicting healthy growth so if you close you eyes and look forward two years and hope there is no slip in the coming eight quarters all will be fine and GMCR may be able to extend their patents. On top of which they have a score and a half other patents.

Some quick thoughts. If Munarriz thinks GMCR is such a good investment why doesn’t he own it? I suggest it’s because like insiders who are consistently selling, he knows GMCR a high risk, low reward investment at current prices. People can talk all they want, but it’s what they do with their money that counts. I think and say GMCR is a poor investment and consequently I don’t invest in it. I actually think it is so bad and the likely fall so large that I’m paying close attention, looking for an opportunity to profit from GMCR’s downward slide.

My main point is GMCR is way overpriced and Munarriz’s rebuff to that was his weakest. The classic cry of emotionally attached bulls, ‘if the company delivers the growth analysts predict then all will be fine’. Unfortunately history tells us analysts have terrible predictive powers and normally grossly over estimate future earnings. If you’re counting on analysts five year growth predictions of 32% for GMCR then all I can do is wish you good luck and offer you a time share in the Sydney Opera House. Does 32% growth for five years pass the smell test? Well if you believe GMCR will achieve their objective “to try to put multiple brewers in households” then it could be possible. Multiple brewers, they’re havin’ a laugh.

I’ll come back to valuation in a minute. Patents are a dime a dozen. Some like GMCR’s main two are of real value, most others have little value. Even if GMCR had 330 more patents I say big deal. Patents with economic value are what’s important and no matter how you look at it there is substantial risk to GMCR’s two main patents. Dress that up however you want, but the reality is a meaningful risk exists. Investors should never ever play down risks and teaching new investors, Munarriz’s main audience, to look the other way or to try and rationalise them is wrong. Successful investors concentrate on the downside. That’s why Buffett’s rule’s number one and two are never loose money. There are thousands of potential investments; consequently, investors should look for reasons to not a stock rather than play down risks.

Whether it’s patents, failing fad, increased competition, write-downs or some other reason the reality is high flying growth stocks inevitably crash. That’s why stocks with P/E’s over 30 are the worst performing group in the market. GMCR’s P/E has climbed to a staggering 60. Last years returns came from earnings growth and ratio expansion. Ratios that expand inevitably contract and earnings growth always slows. While GMCR may find a way to be one of those one in a thousand growth stories with longevity it still will not be a good investment from this point. Companies always stumble, they always have a bad quarter and if their ratios are high they get taken to the woodshed. Study Intel, Apple, Akamai or any other growth stock and you’ll soon see a pattern. There are good times to buy growth companies and bad times. No matter how good the growth, if you buy at inflated valuation levels you will not profit and may loose a substantial amount of your capital.

Some more food for thought.

• TMF”s own CAPS members rank GMCR as a dog, giving it 1 star out of 5.
• Zacks has a price target of $60 of GMCR.
• Here’s an excellent article at TMF which outlines why over priced stocks underperform.
• I would be more convinced by Munarriz if instead of refuting bearish arguments he was able to articulate a good bull case for buying GMCR at current prices.

GMCR may not be a fad, their other patents may have some value, but it just doesn’t matter. There is no way an investment in GMCR at this point will be a long term winner. Even if you believe in their long term potential and can’t find a better investment, (you can’t be trying very hard) make sure you keep a tight trailing stop and be ready to sell a the first sign of weakness. Remember to focus on the downside, don’t look for excuses to keep a stock, look for reasons to ditch it.

Disclosure: No position in GMCR and a poor record of calling shorts!

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