If the market action from Thursday is any indication, investors could be in for a wild ride in the third quarter.  After unemployment numbers were released, the S&P dropped nearly 3% on the day and many growth stocks were hit for much larger gains.  Priceline stock was down on the day but actually held up better than the broad averages.  However, I believe the relative strength will not last and investors might have a great opportunity to short Priceline and profit from a decline in the second half of 2009.

Priceline.com Inc. (PCLN) is one of the primary travel services which offers hotels, flights, car rental, and many other travel services.  The company actually has a very impressive track record with quarter after quarter of growing earnings and sales.  In the first quarter this year, Priceline reported revenue of 462.1 million with EPS coming in at $1.09.  This represented 15% revenue growth over last year and an exciting 43% earnings growth.  The travel business is very seasonal with the first quarter usually representing the slowest quarter so it will be very important to see how the numbers look when Priceline releases second quarter earnings.

As the market traded higher from it’s panic points in October and March, Priceline stock has entertained its share of buyers.  The stock rallied 164% from its October low to peak at $119.14 last month.  Currently the stock sits less than 10% off the high and the company’s solid fundamentals along with the strong stock movement has earned Priceline stock a spot on the IBD 100 roster.  So it may come as a surprise that we are recommending traders short priceline at this juncture in the market.

At this point, Priceline stock is not trading at an enormous or extravagant multiple.  The PE ratio of 16.75 (using 2009 expectations of $6.57 in earnings) reflects a certain degree of investor optimism, but is not close to multiples the stock enjoyed a few years ago during more bullish times.  Unfortunately, we appear to be entering a market period where even just a small amount of investor optimism can be quickly punished with a sharp stock decline.

During positive market and economic periods, we often benefit from the twofold dynamics of increasing earnings estimates, and expanding multiples.  Essentially as companies benefit from the strong economic climate, investors begin to expect profits to grow and the estimates are increased.  At the same time, the stock multiple on the expected earnings expands as investors are willing to pay more for each dollar earned by the company.  The result is often exponential increases in the stock price.

Unfortunately, the opposite can be true during bear markets.  Consider a stock like Priceline trading at 17 times earnings that are expected to be at $6.50.  As high unemployment numbers cause individuals to cut back on vacation plans, and businesses cut travel expenses, analysts could quickly cut those estimates to $4.50 per share which would only be 30% below current expectations.  If investors were unwilling to pay a premium because growth was no longer present, you might see the PE drop to 12 times expected earnings.  The 30% decrease in multiple would actually lead to a 50% drop in the stock (to $54) when you combine both lower estimates and a contracted multiple.

When investing for a few months or a few quarters, perception can be much more important than the actual fundamental numbers.  Over a period of years we will always see stocks trade in a range that represents the fundamentals of the company.  But during shorter time frames it is important to be aware and in front of changes in sentiment and expectations.

It appears after a quarter of rising stock prices which were a direct result of recovery expectations, investors are now set up to be disappointed by a lagging economic recovery.  As this disappointment settles in, we could see many more trading days like Thursday where there are virtually no bids and investors are quickly hitting whatever exits they can find.  Growth stocks like PCLN who are tied directly to the consumer and affected by personal as well as business spending will be most vulnerable.  So I would recommend traders short Priceline with a stop just above $120 and a target near $65 or $70.  If nothing else, long positions should be hedged as the next leg lower could involve significant pain.

FD: Author does not have a position in PCLN

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