After Gaining More Than 80,000%, This Stock is a Short

Almost all of the world’s greatest companies go through the same business cycle. They generally see sales growth start slowly, and then take off rapidly before slowing again. Earnings follow the same general pattern. The ideal time to buy a growth stock is as it transitions to that fast-growth stage, and the time to sell is when that growth slows.

Today, I spotted a company that is about to deliver a quarterly earnings report that should confirm that earnings are slowing.

This company turned natural sodas into an 80,000% stock price gain. After changing its name to reflect a new focus on energy drinks, the company missed earnings estimates last quarter and has formed a topping pattern on the chart. When earnings are released after the close today, I think we’ll see a sell-off, and I want to profit from that.

Monster Beverage (NASDAQ: MNST) was known as Hansen Natural Corporation until January of this year. The name change highlights the company’s fast-growing energy drink businesses. Monster Energy drinks are now the company’s biggest sellers, taking advantage of a distribution network built for Hansen’s Natural Soda products.

Natural sodas may not create as much hype as energy drinks, but this simple product helped build a great company. In the past, sales grew at more than 40% a year and earnings per share averaged 65% a year. Those kind of numbers delivered incredible stock market gains. In 1987, MNST traded at 10 cents a share. Its all-time high, set on April 30, was $83.96, for a total return of 83,860% in 25 years. But after 25 years of market-leading gains, MNST is now a better short trade than a long trade.

Going forward, the company should post respectable numbers. Sales are expected to top $2 billion this year and should continue growing at 15% a year or so in the future, according to analysts who follow the company. Earnings growth has already slowed to less than a third of its former rate, but MNST is expected to deliver steady earnings growth of about 15% a year going forward.

These numbers aren’t bad, but the stock is priced too high based on this level of growth. MNST has a price-to-earnings (P/E) ratio of about 41 based on the recent price. A fair value for the stock would be a P/E ratio closer to 23, the expected annual growth rate. Based on next year’s estimated earnings, MNST is worth about $58, not the $68 it is recently trading at. That sets up a short trade opportunity, which is confirmed by the chart.

MNST Chart

On the chart, we can see that MNST spiked higher at the end of April. Traders were reacting to a rumor that Coca-Cola (NYSE: KO) was looking at buying the company. Since then, MNST has formed a head-and-shoulders top pattern with a high near $80 and support at $65. That $15 range helps identify the first downside target of $50, about 26% below the recent price.

At the time of this writing, the MNST Jan 2013 80 Put is priced at about $15.90. This put will be worth at least $30 if MNST falls to $50, a gain of 89%.

Traders who bought on the buyout rumor are facing losses, and the earnings report could confirm that the stock’s price isn’t going to reach those highs again in the short term. I think MNST will continue lower, probably exceeding the downside target as traders sell to recognize a tax loss later this year. The January put allows us to profit from that selling.

Recommended Trade Setup:

— Buy MNST Jan 2013 80 Put at $17 or less
— Set initial stop-loss at $25
— Set initial price target at $30