As the old maxim goes, “Build a better mousetrap, and the world will beat a path to your door.” That was surely on Nick Woodman’s mind as he was growing up in Silicon Valley, home to numerous innovators. The founder and CEO of GoPro, Inc. (Nasdaq: GPRO) didn’t invent the camera, but he has surely built a better one.

The company’s eponymous line of high-definition wearable cameras have garnered a huge amount of buzz and will help the company blow past the $1 billion revenue mark this year. That’s quite a feat for a company that only broke the $200 million revenue threshold in 2011.

#-ad_banner-#GoPro’s revenue surge has been accompanied by a remarkable upward move in the company’s stock: GoPro’s June 2014 IPO was priced at $24 a share and four months later, shares are trading hands in the low $90’s. As the company’s market value now approaches $12 billion, camera rivals, such as Sony Corp. (NYSE: SNE) and Canon, Inc. (NYSE: CAJ), can only look on with envy. Indeed, few would have guessed there was any innovation left in this consumer electronics niche.

Yet as shares of GoPro keep rising, a simple question comes to mind: Is the company a hardware manufacturer, a social media site or a video editing software firm? Woodman suggests to investors that the company is all of those things. The company is proving quite adept at building a social community and has also paired its impressive hardware offerings with equally impressive software. Still, the current revenue base consists almost entirely of hardware. Which makes a discussion of gross margins quite relevant at the moment.

Most consumer electronics firms generate gross margins in the 25%-to-35% range and, broadly speaking, are valued at one-to-two times sales. Shares of GoPro trade for more than 10 times projected 2014 sales. Only scorching hot growth could justify such a tradeoff between decent gross margins and an astronomic price-to-sales ratio. Analysts expect sales to expand another 20%-to-25% in 2015, yet it will be hard for the company to keep growing at that pace in subsequent years, as I’ll note in a moment.

It is the release of GoPro’s Hero 4, the company’s much anticipated new camera, which explains the key catalyst behind this stock’s surge to $90 from $65 in the past few weeks. The main point behind “catalyst investing” is that you look for upside going into an event and not after the event. Unfortunately, GoPro doesn’t have any more meaningful catalysts on the near-term horizon.

Perhaps the real reason why this stock has just gone vertical is supply and demand. There are just 20 million shares in the public float, which means that GoPro’s bulls are in a scramble to acquire a scarce amount of shares. And GoPro’s bears are having a very hard time locating shares to borrow as they attempt to short the stock. Meanwhile, the fact that more than 10 million shares of GoPro trade hands daily — more than half of the float — tells you that the stock holds greater appeal to traders than investors, many of whom see this as a momentum play and not a fundamental valuation opportunity.

Yet the supply-and-demand factor behind these shares can easily work the other way. When GoPro announces Q3 results later this month, management will be extremely tempted to sell more shares — while they are richly-valued. Indeed over the past few years, we’ve seen many companies pull off IPOs, watch their shares soar and then quickly announce secondary offerings. They’d be crazy not to, as shares have soared nearly 300% in just four months. (In addition, millions of shares will enter the float in December as the lock-up period expires, altering the supply-and-demand imbalance in a big way).

Competition: A Different View
Perhaps lost in all the euphoria around this surging stock is the nature of competition. It’s been widely noted on other financial sites that consumer electronics tend to invite me-too products from rivals, often at lower prices. That can lead to a downward spiral in gross margins and growth rates. Yet it’s too soon to know if GoPro will lose its edge and its cameras will become a commodity.

It’s also unclear how GoPro can finesse a never-ending upgrade cycle. Many of the company’s customers appear quite contented with their current cameras and would need a very compelling reason to buy the newest models. GoPro is banking on many customers to toss out their current cameras and buy the new Hero 4, despite a fairly stiff $500 price tag. Yet with the exception of Apple, Inc. (Nasdaq: AAPL), most consumer electronics companies find it hard to lock customers into a perpetual trade-up mindset.

Risks to Consider: As an upside risk, GoPro could issue very high guidance for the holiday selling season as retailers stock up on the new Hero 4 camera.

Action to Take –> Remember the Flip camcorder? It was all the rage in 2009, but Cisco Systems stopped selling the camera by 2011, thanks to a sharp drop in demand. There’s no reason to expect GoPro to meet such a harsh end, but Cisco’s experience should remind you not to get carried away when it comes to the latest hot consumer item. Yet current valuations suggest GoPro investors have gotten carried away. This is a company with no margin for error, few upcoming catalysts, facing an imminent expansion in the supply of stock available.

Short sellers were badly burned when shares traded for $50 or $60 a few months ago. But with shares now trading at $90, they possess one of the most compelling opportunities available to short sellers right now. A pullback to $65, where shares stood less than a month ago, seems to be the likely result when Q3 results are released on October 30. That’s when GoPro will likely succumb to the temptation to issue more shares, and the scarcity factor will evaporate. Such a pullback represents a 30% short-term gain.

Short selling is a solid move — if you can find shares to borrow. The scarcity factor has led many short sellers to buy Dec14 and Jan2015 puts, each of which would spike sharply in value if underlying shares pull back below $75.

Shares of GPRO got off to such a phenomenal start because the company’s product is a game-changer. Our premium newsletter, Game-Changing Stocks, is devoted to highlighting companies exactly like GPRO. In fact, we just released our newest report, “The Hottest Investment Opportunities For 2015.” To learn more about the next big thing and how to invest in it, click here.