Stock Quotes in this Article: AMT, BIDU, CMG, LVS, NFLX, RHT

 MINNEAPOLIS (Stockpickr) -- Recent trading activity for Netflix (NFLX) provides investors a cautionary tale with respect to stocks with big valuations. After crossing $200 per share at the end of November, shares of the home delivery of video giant have dropped by more than 10% in December.

Investors take note: The higher they climb, the harder they fall. For those chasing returns or momentum stocks, buying Netflix at the end of November would have been a mistake. Are there other stocks trading for big valuations investors should now avoid?

Certainly the warning signs were there for Netflix. Prior to November, the stock was a big winner. Shares had more than tripled in value in 2010 thanks to earnings growth and a future that many predicted was unlimited.


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    Ah, the unlimited future growth prospect story is as old as the hills. We only need to go back to the dot-com boom to see how badly such stories ended. There is no such thing as unlimited perpetual growth, and everyone knows it, yet that does not prevent some stocks from rising to lofty valuations.

    As tempting as it may be to chase a momentum stock, investors may be best served by staying on the sideline in certain cases. The trick is to know when to say when. Leave the party too soon and gains are left on the table. Leave too late and losses result.

    Here then are five stocks that have grown to have very large valuations that I would avoid today.

    Red Hat

    Investors are in love with the cloud computing story. Anything resembling a cloud gets bid up like crazy. It is the hot thing in technology at the moment. Benefiting from the craze is Red Hat (RHT). The Linux open operating system company has seen shares nearly double in price in the last several months.

    Analysts are stepping up estimates one by one. Each new rating comes with an upward adjustment of the numbers. The sky is the limit. Well, let’s not get too excited here. It is time for a reality check.

    At current prices Red Hat trades for 106 times trailing earnings and 52 times February 2012 estimates. In addition, shares trade for 11 times sales and almost 8 times book value. Those numbers should make anyone nervous no matter how exciting the prospects.

    I would highly recommend taking money off the table if you own shares. This sort of valuation typically ends badly.

    TheStreet Ratings has a buy rating on Red Hat, earning the stock a spot in its Top-Rated Software Stocks portfolio.

    Las Vegas Sands

    Like Netflix, Las Vegas Sands (LVS) has seen its stock triple in value in 2010. Optimism over its property in China has helped propel shares higher even as properties in Vegas languish thanks to a struggling U.S. economy.

    The allure is simple: A growing middle class in China with its billion-or-so population ensures that properties such as Las Vegas Sands will print money. I love gambling stocks, but one must draw a line in the sand at some point.

    Growth in cash flow is not unlimited, and the increase in price at Las Vegas Sands leaves little room for error. Shares trade for nearly 50 times the 2010 earnings estimate of $1 per share.

    Perhaps that is justified given the estimate of $1.69 in 2011, but I would be cautious. Such growth is simply not sustainable. At 5 times sales and book value, Las Vegas Sands has become expensive. Earnings will not grow as fast in future years.

    Buyers today would be buying at the peak in my opinion.

    Recent buyers of Las Vegas Sands include Louis Navellier at Navellier & Associates, which increased its position in the stock by 5,607% in the most recent reporting period. The stocks is also a holding of the CGM Focus Fund, and it was recently included as one of the five-star stocks for 2011 recommendations of Nainesh Shah, portfolio manager for the five-star Roosevelt Multi Cap fund.

    Chipotle Mexican Grill

    I love the Mexican food at Chipotle (CMG), but let’s think a bit more reasonable about the stock. While this company has hit a homerun with its performance and quick acceptance by the market place, trends can change.

    What is hot today may not be hot tomorrow. Chipotle reminds me of the buzz back in the late 1980s around another fast food concept. Does anyone remember the Boston Chicken craze?

    Okay, perhaps the analogy is not the same, but it does merit some consideration. After more than doubling in value this year, Chipotle now has a very rich valuation. Shares trade for 45 times trailing earnings, 36 times forward earnings, 4 times sales and 10 times book value.

    I’ll eat the burrito, but I would not buy the stock at these levels. I think investors are setting themselves up for a fall if they do.

    One big bet on Chipotle, as of the last reporting period, was made by Renaissance Technologies, which increased its position in the stock by 422%. With a buy rating, the stock is one of the top-rated restaurant and hotel stocks by TheStreet Ratings, and it was one of the 10 restaurant stock winners of 2010. StreetAuthority's David Sterman, however, says it'd be crazy to buy the stock at recent prices.


    Google taking a stand against censorship in China opens the door for homegrown internet portal Baidu (BIDU). Shares of the Chinese company have more than doubled this year thanks to the impression that Chinese adoption of the Internet and its use will be unlimited.

    Can the company convert the hype to reality? That remains to be seen, but investors looking at the stock today ought to be cautious. Recently, the Chinese government has been aggressively raising domestic interest rates in order to slow growth and prevent inflation.

    There is wonder in the China miracle, but growth does not last forever. Adam Smith understood that concept hence the idea of the business cycle. Things go up and they go down.

    We are seeing the warning signs at Baidu. Will you heed the call to perhaps take a step back? You should in my opinion.

    Shares trade for 82 times trailing earnings, 42 times forward earnings, a whopping 34 times sales, and 32 times book value. That is simply crazy and should be avoided at all costs.

    As of the latest reporting period, Baidu makes up 2.2% of Ken Fisher's portfolio and 6.84% of Robert Karr's at Joho Capital.

    American Tower

    The world goes wireless, and benefiting from the expansion will be American Tower (AMT). Investors believe the opportunity for the wireless infrastructure company is unlimited. I’m not so sure.

    The time to buy this stock was last year when shares were half as much as today. At current prices, AMT trades for 59 times trailing earnings, 46 times forward earnings, 11 times sales and 6 times book value.

    You're unlikely to see Warren Buffett or other value managers buying this stock any time soon. If the market goes south, this stock could be falling like a knife. There is no reward for taking the risk today.

    I would avoid this stock at the moment.

    To see these stocks in action, check out my 5 Highfliers to Avoid Now portfolio.

    -- Written by Jamie Dlugosch in Minneapolis.


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    At the time of publication, author had no positions in stocks mentioned.

    Jamie Dlugosch is a founder and contributor to MainStreet Investor and MainStreet Accredited Investor. Formerly, he was president and CEO of Al Frank Asset Management. He has contributed editorially to The Rational Investor, The Prudent Speculator, Penny Stock Winners and InvestorPlace Media.