How to Avoid Buying into the Next ‘Hot Stock’ Bubble

The stock was unstoppable in 2015. It rallied 714.97%, to $13.61 per share. This unknown little company was making a big name for itself. They captured immense demand from China. They had to fight just to keep their product on the shelves. They told shareholders that there was plenty of growth left in the tank.

It’s a problem that many businesses wish they had.

You probably guessed I’m talking about Bellamy’s Australia Ltd [ASX:BAL].

Bellamy’s made early investors some great returns. It’s those who bought into the ‘hot stock’ myth well into bubble territory that are now licking their financial wounds.

The current situation at the baby-formula company is far from rosy. From the start of 2016, the stock has fallen more than 72%. Only those who got in at the very start of 2015 are still sitting in a positive positon. Yet their potential returns have been severely reduced.

Well, there are some outside factors, to be sure. But I place the bulk of the blame squarely on management.

What happened to Bellamy’s shows you just how important a strong management team is to a company’s fortunes. You can have a great product, and the right strategy. But if you don’t have the right people executing, things can get out of hand.

Of course, it’s not easy to tell from the outside what management is doing on the inside. That’s why, to their detriment, most investors tend to focus on financial or technical (charting) information. Management is usually an afterthought.

That’s a mistake. The right management is extremely important for a business to succeed. It’s something you might want to pay closer attention to in the future. You don’t want to have the next Bellamy’s in your portfolio, do you?

When it all fell apart

Reported by the ABC:

At the October meeting, the success of Bellamy’s in China was heralded with “revenues up 331 per cent” and regulatory changes were portrayed as “long-term growth opportunities”, with chief executive Laura McBain informing investors that the company had been planning for the changes “for two years”.

But an update on 2 December, 2016, revealed a completely different outlook.

Chinese sales weren’t everything they had hoped for. The company had a problem with moving inventory. And it was largely due to new regulations in China. Management overestimated demand and oversimplified the regulations.

McBain tried to reassure investors saying Bellamy’s strong brand was key.

The Company’s approach to being a 100% certified organic brand is a key differentiator, and the reason why more than 110,000 people follow Bellamy’s on Facebook in Australia, and thousands more across social media platforms in China, Singapore, Malaysia and Vietnam.

But Facebook likes weren’t enough to stop a mass selloff in shares. The stock dropped 43.53%, to $6.85, on the day. One of the biggest sellers was FIL Investment Management. They sold 1.88 million shares on the day.

A few days later, the company requested a trading halt. Their aim was to stop the selling frenzy for as long as they could. The halt extended until 11 January, 2017, putting investors in limbo.

But the break in trading didn’t do much to stop further selling. The stock opened down 34.97%, to $4.35, at the turn of the new year.

In an update, the company said the halt was necessary. They needed time to sort out their financial situation. Yet in doing so, they prevented shareholders from exiting an already losing position.

Demand was lower than management expected. And it led to mounting inventories, causing a shortfall in payments to suppliers. Because of such poor performance, management changed. Laura McBain stepped down from her position as CEO. And questions arose surrounding the abilities of other executives.

Not long after, a class action suit was heading for Bellamy’s. Shareholders believed the company misled them with information about trading and future earnings.

It’s completely understandable that shareholders are angry. They entrusted their money to a management team that promised growth and didn’t deliver.

The good news is that you can avoid buying the next Bellamy’s at the tail end of the bubble. But, to do so, you’ll need to keep a close eye on management…as well as their books.

Question everything

Not that long ago, analysts were bullish on Bellamy’s. The stock was tipped to climb 30–65% over the next 12 months. But there was a Tassie fund manager who didn’t buy the hype.

Tim Hannon believed Bellamy’s didn’t properly understand their supply chain. It turned out he was right. And he saw their coming collapse before others.

They suffered from the bullwhip effect, Hannon said. This is where swings in inventory increase when responding to demand. In Bellamy’s case, they ramped up production to meet demand.

But management had overestimated demand. They were left with inventory worth millions, which they couldn’t sell.

Bellamy’s management also made some questionable trades in early 2016. Chairman Robert Woolley and CEO Laura McBain sold shares. It’s something management does from time to time. And it is their right to do so.

But Woolley and McBain sold when Bellamy’s was trading at around $14.50. Both pocketed around $2.92 million and $2.39 million respectively. Hardly a sign of confidence to shareholders going forward.

That’s why it’s so important to keep your eye on a company’s management. Question the future of earnings of all the stocks you’re currently in. If you’re looking to jump into an investment, don’t forget to analyse the management team. What’s their track record like? Do they overestimate earnings? When is the last time they bought or sold company shares?

Question their trades, predictions, guidance, and everything else. It could save you from buying stocks which promise growth, but ultimately fall short.


Härje Ronngard,
Contributing Editor, Money Morning

PS: Small-cap stocks can be extremely exciting. But you don’t want to be on the other side of the next Bellamy’s. Along with Tim Hannon, our small-cap specialist, Sam Volkering, also saw the coming downfall of Bellamy’s.

He recommended selling out of Bellamy’s in his advisory service, Australian Small-Cap Investigator, for a 575% gain. While the stock continued to rise for a short while, Sam had the right idea to lock in a huge gain when he did. Staying in the stock too long would have seen potential returns rapidly disappear.

To find out how Sam can help you get explosive returns while avoiding the next Bellamy’s, click here.

From the Port Phillip Publishing Library

Special Report:The Lazarus Project’ Your best chance to double every dollar you invest this year [More…]

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

Money Morning Australia