Vahan Janjigian, Ph.D., CFA | On October 13, 2014

Nick Woodman, founder and CEO of GoPro.
(Photo by David Paul Morris / Getty Images)

Some stocks go up and some stocks go down. But some stocks go up no matter what–even when the market takes a big plunge. Take GoPro, Inc. (GPRO), the maker of wearable cameras. The company’s various products are extremely popular with narcissistic extreme-sports enthusiasts who want to see themselves perform their favorite activities in extremely high-definition. The cameras are hot sellers on Amazon.com (AMZN).

Revenues for the three months ended in June were up 38% year-over-year. That’s the kind of growth that makes momentum investors salivate. Unfortunately, the company isn’t yet turning a profit. It lost $20 million that quarter, almost four times as much money as it lost in the year-earlier quarter. Thanks to non-cash expenses such as depreciation and stock-based compensation, however, GoPro managed to generate a small operating cash flow.

Investors are clearly betting that the strong revenue growth will soon translate into big profits. Analysts are currently forecasting earnings of just eight cents per share this quarter, 82 cents per share for 2014, and $1.04 per share for 2015. That means the stock is selling for almost 100 times the earnings per share that are expected more than a year into the future.

The stock is expensive by other measures, too. Market capitalization is more than $12 billion, yet GoPro’s book value is only $47 million. And if things go according to plan, the company will generate only about $1.5 billion in sales in 2015. But things may not go according to plan. After all, there is nothing to keep competitors such as long-time camera experts Nikon and Canon from coming out with their own high-definition products. Polaroid, long considered a has-been, already has a competing product on the market that sells for just $99.

Polaroid’s camera is not as good as GoPro’s Hero cameras, but that’s not the point. The point is that GoPro shares are overvalued. One reason the stock price is so high is because growth-oriented momentum investors are buying it like crazy. The more important reason is that it is almost impossible to short the stock. If investors can’t short the stock, the price can only go up.

Regulations prohibit “naked” shorting. This means that brokers must be able to get the stock before they can let investors go short. Yet once investors are short, there is no guarantee that they can stay short. For example, if the broker borrowed the stock from another investor who was long, the broker must return it when that investor wants it back. As a result, the broker can force the shorts to close their positions even if they have plenty of margin available in their account.

Investors who are long GoPro are not making the stock available for shorting. Investors who did manage to go short, are now being forced to buy back the shares, creating the inevitable short squeeze. That’s the real reason the stock price has been rising.

But GoPro shares are sitting on a foundation of straw. As is common with IPOs, insiders are subject to a lockup agreement. This means they cannot sell their shares until 180 days after the offering date. As a result, a potentially large amount of GoPro stock could become available for sale at the end of December. That alone could drive the stock price significantly lower.

Just a few weeks ago we saw the stock briefly plunge when word got out that Nicholas Woodman, the company’s founder, wanted to break his lock-up agreement with the underwriters in order to put almost 6 million shares into a charitable foundation that he and his wife created. The stock fell in reaction to the news even though the foundation had no immediate plans to sell the shares. Just the mere possibility that so many shares might become available for sale made bullish investors extremely nervous.

GoPro is an extremely overvalued stock, yet there’s no telling for sure when the selloff will begin. If might not happen until the very end of the year when the lockup expires and employees start selling. However, it could happen sooner if investors begin to anticipate the lockup expiration and sell in advance.

Disclosure: Vahan Janjigian is long put options on GoPro.

Read Vahan’s blog at Janjig.com.

Vahan Janjigian, Ph.D., CFA

Vahan Janjigian is Chief Investment Officer at Greenwich Wealth Management, LLC, a SEC Registered Investment Adviser, where he manages portfolios for clients in separate accounts. Dr. Janjigian is a former Forbes magazine columnist and former Editor of the Forbes Special Situation Survey. According to Hulbert Interactive, his stock picks returned more than 18% annually during one of the market’s worst 10-year periods.

Dr. Janjigian holds the Chartered Financial Analyst designation and has earned degrees in general sciences and finance from Villanova University and Virginia Polytechnic Institute and State University (Virginia Tech). He previously served on the faculties of several universities, including the University of Delaware, Northeastern University, the American University of Armenia, and Boston College, where he taught courses in corporate finance, financial theory, investments, accounting, and economics; and he currently teaches a seminar on equity investment management to business executives in Singapore through Baruch College’s Zicklin School of Business. Dr. Janjigian has served as an expert witness on matters involving portfolio management, churning, suitability, and hedge fund manager compensation.

Dr. Janjigian has published his research in numerous scholarly and professional journals; and has been quoted in many leading newspapers and magazines, including Barron’s, Forbes, The Wall Street Journal, and USA Today. He appears as a guest commentator on various television and radio networks, including Fox, CNBC, MSNBC, and CBS Radio. Dr. Janjigian is the author of Even Buffett Isn’t Perfect (published by Penguin) and co-author of The Forbes/CFA Institute Investment Course (published by Wiley).