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Boston Herald

By Chuck Jaffe

Investors love stocks with the potential to become brand names and are willing to overlook a lot of performance issues in hopes of catching the next household giant.

Couple performance and financial concerns with public worries that the stock is being manipulated on the open market, however, and you've moved into uncharted territory.

For the average investor, overlooking that trouble and wading into those waters is asking to get blown up, which is precisely why Overstock.com has become a Stupid Investment of the Week.

You would practically have to live under a rock to not know Overstock, which has built a brand as a leading electronic retailer specializing in liquidation. Last year, the company broke into the top 50 visited Web sites, according to Media Metrix, the kind of rarified status that excites investors. Sales growth has been impressive, with the company doubling its number of customers over the last year.

That's enough to entice average investors, but it's not enough to keep Overstock out of the danger zone.

For early investors in Overstock, the concern is capital gains. The company was up more than 50 percent in 2003 and almost 250 percent in 2004, before being cut in half thus far this year.

That kind of performance highlights the bumpy road this stock has traveled. Most observers think it will get even rougher from here.

Sales have increased from a pittance in 1999 to just under $500 million last year, which earns Overstock a growth grade of A from Chicago-based research firm Morningstar Inc. Many analysts are forecasting a profit from the company next year.

But those expectations were dampened by poor third-quarter results. Sales growth slowed. Operating expenses grew by a higher percentage than revenues. And marketing costs nearly doubled.

Morningstar gives Overstock a D+ grade for financial health and an F grade for profitability. For an average investor, a good balance sheet is more important than sales growth, so these more- fundamental marks are telling.

Analysts have now dropped estimates for the company's stock into the high $20 or low $30 range, below the current market price.

And while average investors love a good "story stock" and might hope that Overstock is the next Amazon.com, institutional investors weren't so sweet on it, as more than half of the action in the stock has been by short-sellers.

In fact, Overstock CEO Patrick Byrne has been waging a personal battle against hedge funds and short-sellers. In August, Byrne held a conference call in which he basically said that everyone from hedge funds to journalists to regulators had all been scheming to destroy his company; he said the plan was being orchestrated by someone he identified only as the "Sith Lord."

That's weird.

Byrne blames "naked shorting" for helping to drive the share price down. That's when sellers register the trade without actually borrowing the shares.

In most cases, the practice is illegal, in part because it allows the short-seller to put unlimited pressure on the stock. (They can simply keep trading in shares that don't exist to turn up the heat).

The trouble is that naked shorting is hard to prove or disprove. That's why most CEOs simply ignore it, keeping their eye on the ball of building a fundamentally healthy company.

Rob Plaza, who follows Overstock for Zacks Investment Research, points out that "in general, when the CEO or upper-level management is taking the focus away from things they can control to other things - like naked shorting - which they can't, it's a real problem."

An even bigger problem is when a CEO suggests that his company's stock is being manipulated, he's saying that if you invest, you have chosen to sail with the monsters.

Byrne acknowledges as much.

"I don't give stock advice, but the average investor probably should steer clear of Overstock," Byrne said Thursday.

That's doubly weird. And it's a clear warning to steer clear.

"Obviously, I believe in the future of this company," Byrne said. "But for as long as regulators keep giving hall passes to the criminals who are doing the counterfeiting in our stock, the small investor should stay out."

Send e-mail to: jaffe@marketwatch.com