Green Mountain has seen its stock rally from the low 20’s in November to over $50 as I write.  Investors have become giddy with the prospects for a real-for-sure economic recovery and have bid many of their favorite growth stocks much higher.  Since Green Mountain has a novel product and the company is growing rapidly, it makes sense that the stock would be in high demand.

Coffee has traditionally been brewed by the pot.  Or if you’re a purist like me, occasionally you would use a french press.  But the idea of a single serving of coffee has traditionally not worked (after all – why drink one cup when you can have a whole pot?).  Green Mountain has changed that approach with their patented K-cup process which brews coffee one cup at a time.  The strategy is genius because not only does the company get revenue from selling a relatively high-priced machine to customers, but then GMCR has a virtual monopoly on that customer who will buy the individual ground packets from the company for the life of the machine.

GMCR has grown earnings quite steadily over the past few years.  In 2007, the company earned 63 cents per share compared to 39 cents the year before.  2008 saw earnings climb to nearly a dollar per share, and analysts are expecting $1.32 for 2009.  Impressive growth usually leads to an impressive multiple on the stock and that’s exactly what GMCR has.  As I write, the stock is trading north of $53 after hitting a new 52 week high Monday.  That price represents a multiple of more than 50 times current earnings, and more than 40 times this year’s expectations.

Now at this point I’m not willing to bet against an economic recovery, but I can say for certain that there will be disappointments along the way.  Markets have enjoyed the best short-term rally we have seen in decades and whether that rally continues or not, I think we are set up for some consolidation and possibly a sharp decline to test investor’s steel.

Now similar to my thoughts on Netflix and Blue Nile, a call to short Green Mountain is quite aggressive.  It is usually quite risky to short a stock that is making fresh 52 week highs.  But at the same time, I’m fairly confident that this stock will have a sharp pullback in the coming weeks and one that could be very profitable if timed quickly.  The best opportunity in this name might be to buy puts instead of shorting the stock outright – thereby capping risk to a manageable level.  The downside with owning puts, however, is that you have a limited time horizon and must pay extra premium to account for the lower risk profile.

In short, this appears to be a good time to have some defensive positions on the field.  The ZachStocks Growth Model has outperformed the market this month but in the last few days we have instituted a couple of short ETF’s to guard against the potential for declining prices.  Disciplined trading requires the willingness to approach the market from both sides and to cut back on exposure when risk is higher.  Shorting GMCR could be just the ticket to offset some of that long exposure.

FD: Author does not have a position in GMCR
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