Thursday, June 30, 2011

2 Reasons to Buy, 2 to Wait on Visa Stock

Visa (NYSE: V) stock was up 15% Wednesday after the Federal Reserve approved higher than expected debit card fees. Should you buy the stock now or does its current price reflect all its upside earnings potential?

The Fed was expected to limit so-called debit-card swipe fees, also known as interchange fees -- paid by merchants and pass the money to card issuers -- to 12 cents a transaction. The pleasant news for investors was that the Fed actually approved a 75% higher 21 cents per transaction limit, effective October 1.

The bad news is that the new interchange fees will be less than the old average of 1.14% of the purchase price. But since the fee was higher than investors expected, Visa stock rose.

There are two good reasons to buy Visa stock:
  • Long-term financial strength. Visa's revenues of $8.6 billion have risen at a 24.8% average annual rate in the last five years while its profits soared at a 62.1% annual rate to $3.3 billion -- yielding a high 37.7% net profit margin. Visa has a tiny speck of long-term debt -- 0.1% of equity and its cash balance has increased at a 44.4% annual rate from $931 million in 2006 to $4,051 million in 2010. 
  • Strong second quarter earnings. In the quarter ending March 2011, Visa's operating earnings of $1.23 per Class A common share were three cents more than Zacks Consensus Estimate. Visa's revenues rose 14.6% to $2.25 billion, 1% more than Zacks Consensus Estimate of $2.23 billion.
There are also two pieces of mixed news:
  • Visa stock is not cheap. Visa trades at a price-to-earnings-to-growth (PEG) ratio of 1.24 (where 1.0 is considered fairly valued). Visa’s P/E is 19.3 on earnings expected to climb 15.6% to $5.68 a share in 2012.
  • Progress in trying to earn more than its capital cost. Visa does not earn enough in after-tax operating profit to offset its cost of capital. But it is getting much closer. After all, it’s producing positive EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales. In 2010, HP’s EVA momentum was up 9%, based on 2009 revenue of $6.9 billion, and EVA that improved from negative $704 million in 2009 to negative $69 million in 2010. If its EVA Momentum continues at this rate, it looks like Visa will generate positive EVA in 2011.
My conclusion is that Visa is a very strong company whose stock I would consider buying on a market dip. With the volatility I expect during July negotiations on the debt limit, it would not surprise me to see some big down days on the market. And those days might be good ones to consider picking up Visa at a lower price.

Wednesday, June 29, 2011

3 Reasons For HP Stock, 5 Against

Hewlett-Packard (NYSE: HPQ) is opening up a hardware research and development operation in Beijing. Is this China foray a signal that you should buy HP stock? There are two reasons to buy HP stock and two against.

HP sells all information technologies to all segments. HP sells those products and services through five operating groups including:
  • Services -- systems consulting services to organizations,
  • Enterprise Storage and Servers (ESS) -- storage and computing hardware to organizations,
  • HP Software -- corporate software,
  • Personal Systems Group (PSG) -- personal computers and related systems, and
  • Imaging and Printing Group (IPG) -- printing and scanning hardware.
And it sells them, in a targeted way, to individual consumers, small- and medium-sized businesses (SMBs) and large enterprises, including customers in the government, health and education sectors.

Why buy? Here are three favorable factors:
  • Good five year income statement. HP has posted respectable financial results. HP's revenues are a whopping $128 billion, growing at 7.8% average rate since 2006 and its net income of $9.2 billion has risen at an impressive 29.6% average annual rate over the last five years.
  • Growth in Economic Value Added. HP is generating a positive return for its capital providers. After all, it’s producing slightly positive EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales. In 2010, HP’s EVA momentum was 1%, based on 2009 revenue of $114.6 billion, and EVA that grew from $1.1 billion in 2009 to $1.7 billion in 2010.
  • Expansion into China. HP plans to open a research center in Beijing in 2011 and will hire an unspecified number of engineers to develop global storage and networking products. HP gets 12% of its sales, $3.7 billion worth, from so-called BRIC countries -- Brazil, Russia, India, and China. But HP is not new to China. It began operating there in 1985 and about 20,000 HP workers call China home. This is good news but would not make a huge impact on overall sales.
Why steer clear? Here are five reasons:
  • Weakening balance sheet. But its balance sheet has deteriorated over that time. For example, its cash balance has declined at a 9.7% annual rate from $16.4 billion in 2006 to $10.9 billion in 2010. During that same period its debt has skyrocketed at a 57.3% annual rate from $2.5 billion to $15.3 billion. And in the last year, its stock has lost 23% of its value to $72.8 billion.
  • Poor second quarter performance. HP's second quarter performance was disappointing. For the second quarter, HP said its earnings would be $1.08 a share -- 12.2% below analysts' estimates -- the second straight quarter HP missed forecasts, according to Bloomberg.
  • Lowered 2011 expectations. HP also slashed its full-year projections. It cut a billion dollars from its 2011 sales forecast and missed analysts’ profit projections as consumers shunned PCs and services margins narrowed. Specifically, HP announced on May 17 that its 2011 will be between $129 billion and $130 billion while EPS will be "at least $5 a share." Analysts in a Bloomberg survey estimated sales of $130.3 billion and earnings of $5.24.
  • Fairly expensive stock. And HP's stock valuation is just a little pricey — trading at a price-to-earnings-to-growth (PEG) ratio of 1.23 (where 1.0 is considered fairly valued). HP’s P/E is 8.6 on earnings expected to climb 7% to $5.36 a share in 2012.
  • Questionable CEO. Is CEO Leo Apotheker going to work out? Before arriving at HP in November 2010, Apotheker resigned as CEO of a German software maker, SAP AG. But he left amid falling sales, a union battle over job cuts and a price increase that angered customers. Will this experience help him solve HP's problems or will he end up producing the same results that prompted his departure from SAP?
The reasons not to buy HP stock outweigh the three that favor it. I would wait until this balance tilts more in HP's favor.

Tuesday, June 28, 2011

Are Cloud Apps A Catalyst to Add Google to Your Portfolio?

Google (NASDAQ: GOOG) is saving large organizations millions by persuading them to swap Microsoft (NASDAQ: MSFT) Office applications for Google's so-called cloud-based software as a service. Should you add Google to your portfolio?

At least one 25,000-person organization, InterContinental Hotels, has taken its employees off Microsoft email and Office applications and on to Google's Cloud Apps, according to the New York Times. For a typical business, Google charges $50 per user per year to use its email and office applications that are delivered from Google's computing systems. InterContinental estimates that Google Cloud Apps will save it millions.

And InterContinental is not the only one to stick a knife in the heart of Microsoft's $20 billion a year, 60% operating margin Office business. Here are others that switched to Google Cloud Apps, according to the Times:
  • The National Oceanic and Atmospheric Administration, (25,000 employees)
  • State of Wyoming, (10,000); and
  • McClatchy Group (8,500).
Microsoft is fighting back by introducing its Office 365 for $72 a year. While the idea of competing with Microsoft Office has been around for a while, Google appears to be the first to gain significant traction -- it has improved its offerings considerably since they were first introduced.

Google's revenues from these four alone could total $3.4 million (assuming they are paying full price) and almost 100% of Google Cloud App customers renew the service. Most likely, these employees are likely to be drawn in to other Google revenue generators so the relatively tiny Cloud App revenues could benefit Google in other ways.

Nevertheless, an investor in Google shares at this price, must consider the rest of its business and whether Google has the potential to deliver compelling upside surprises beyond Cloud Apps. Google stock had a great run between its 2004 IPO at $80 a share and its September 2007 peak of $567 -- rising at a compound annual growth rate of 92%. But the stock has since bounced around and is now trading 15% below that peak.

Nevertheless, Google's financial performance has been spectacular. In the last year, its revenues were $31 billion, up 36.7% a year over the last five years. And its net income of $8.4 billion rose at a 5-year average annual rate of 42.2%. Meanwhile Google's cash balance grew at an annual rate of 33% to $35 billion at the end of 2010 since 2006 while holding barely any debt.

Google's most recent quarterly performance was worse than expected due to its massive hiring campaign. In the first quarter of 2011, Google's net income of $2.3 billion up 18% from the year before, or $7.04 per share, compared favorably to 2010's $6.06 per share. Its adjusted EPS of $8.08 per share was three cents below analysts surveyed by FactSet.

While Google revenue was about $8.6 billion, up 27% and 37% better than analysts expected, Google's expenses grew faster than revenue -- with Google adding 1,916 employees to end March 2011 with over 26,300 workers.

Is Google investing too much in its human capital to generate a positive return to its capital providers? No way -- it is earning huge returns on capital. After all, it’s producing positive EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales.

In 2010, Google’s EVA momentum was 3%, based on 2009 revenue of $23.7 billion, and EVA that grew from $3.1 billion in 2009 to $3.9 billion in 2010.

And Google's stock valuation is reasonable — trading at a price-to-earnings-to-growth (PEG) ratio of 0.94 (where 1.0 is considered fairly valued). Google’s P/E is 18.7 on earnings expected to climb 20% to $35.43 a share in 2012.

While I don't expect Google Cloud Apps to make a big difference in its overall revenues, Google stock is likely to pop if all those new employees can invent services that actually generate new sources of revenue growth.

At its current price, there could be more risk by not investing and missing Google's upside over the longer-term.

Monday, June 27, 2011

Is Chesapeake Energy Stock Overvalued?

Chesapeake Energy (NYSE: CHK), the natural gas producer, may have exaggerated the value of its natural gas inventories. If so, its stock could be over-valued. If not, is it a bargain?

Chesapeake is an $8 billion (annual sales) producer of natural gas and oil and natural gas liquids in the United States. At the end of 2010, it owned 46,000 producing natural gas and oil wells that produced 3 billion cubic feet of natural gas equivalent (bcfe) per day. In so doing, it has grown revenues at 22% and its most recent net income of $726 million was up 128% from the year before.

Chesapeake is among the shale gas producers -- users of an extraction technique called hydrofracking that forces water into deep-underground rock formations to force natural gas to the surface -- whose supply estimates may be exaggerated. According to the New York Times, in April, a Chesapeake executive told an energy industry conference, “Shale gas supply is only going to increase.”

But Chesapeake engineers wrote emails contradicting the optimistic premise. According to the New York Times, the emails suggest that the magnitude of Chesapeake's shale reserves are significantly overestimated because they project decades of steady output when in fact production declines after the first year and the cost of retrieving the gas exceeds the profit from selling that supply.

According to a March 17, 2009 Chesapeake memo reviewed by the Times, "Our engineers here project these wells out to 20-30 years of production and in my mind that has yet to be proven as viable. In fact I’m quite skeptical of it myself when you see the % decline in the first year of production.” On March 16, 2009 that same geologist wrote, “In these shale gas plays no well is really economic right now. They are all losing a little money or only making a little bit of money.”

Moreover, major shale gas wells are producing at most 20% of the expected production. According to the Times, in three major shale formations — the Barnett in Texas, the Haynesville in East Texas and Louisiana and the Fayetteville, across Arkansas — "less than 20 percent of the area heralded by companies as productive is emerging as likely to be profitable under current market conditions."

If you believe Chesapeake's numbers, it produced weak first quarter financial performance -- but better than analysts expected. It reported a $205 million (loss of 32 cents/diluted share) in the quarter compared to a profit of $732 million or $1.14 cents per share in the 2010 first quarter. Its adjusted net income of 75 cents/share; however, was a nickel more than the mean analyst estimate.

Chesapeake's loss comes on top of a significant pile of debt. Specifically, it has $13.4 billion in long-term debt. But investors responded positively to the company's assertion that it wants to reduce its debt by 25% by the end of 2012.

And Chesapeake valued its reserves at a present value of $3.7 billion. When compared to its market capitalization of $18.4 billion, it appears that investors are valuing those reserves at 5 times their present value. While this appears very high, it would be even higher if it turns out that the estimate of its shale gas reserves -- that account for about 78% of its total reserves -- are way overstated as the Times suggests, then Chesapeake's market value could also be way too high.

All this production requires a significant amount of capital -- is Chesapeake generating a positive return to its capital providers? In a nutshell, no, but it's improving. After all, it’s producing positive EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales.

In 2010, Chesapeake’s EVA momentum grew 134%, based on 2009 revenue of $7.7 billion, and EVA was negative in both years but getting much less bad in 2010 from negative $11.3 billion in 2009 to negative $979 in 2010.

And the stock is very expensive — trading at a price-to-earnings-to-growth (PEG) ratio of 3.51 (where 1.0 is considered fairly valued). Chesapeake’s P/E is 26.7 on earnings expected to climb 7.6% to $3.16 a share in 2012.

With a chance that its reserves are over-stated, its EVA destruction, its high debt load, and its very high market valuation; it's hard to make a bullish case for this stock.

Friday, June 24, 2011

Is Acme Packet Too Pricey?

Since its Oct. 2006 IPO, Acme Packet (NASDAQ: APKT) has risen from $17 to as high as $75.69 last month -- that's a nice 37% compound annual growth rate for shares of this maker of communications gear. In the last month, this high flyer's stock fallen 10% -- is that a buy signal?

Acme Packet makes equipment that helps people communicate. More specifically, its so-called session border controllers (SBCs) let groups of people in different locations conduct voice and video communications sessions across their networks. Acme Packets' customers include service providers, enterprises, government agencies and contact centers.

Acme Packet has made a good living making and selling SBCs. In the last five years, its sales have grown at a 45% average annual rate to $254 million leading to a $4.9 billion market capitalization. And it in the last 12 months it earned $48 million profit -- a solid 19% net margin.

Not only that, but Acme Packet is generating cash with a secure balance sheet. It has no long-term debt and its cash has grown at a 17.9% annual rate from $119 million in 2006 to $271 million in 2010.

Acme Packet is a leader in a fast growing market. According to Exact Ventures, the enterprise SBC market grew 55% in the year ending March 2011. This growth is a result of organizations buying new SBC technologies -- specifically so-called SIP trunk and hosted unified communications (UC) services.

Acme Packet leads in two big segments -- companies and communications service providers. Cisco Systems (NASDAQ: CSCO) is in second place, followed by some smaller competitors. However, since the industry remains fragmented -- with 20 competitors -- price competition is intense.

In the first quarter of 2011, Acme Packet delivered strong performance that was below Wall Street expectations. Its revenues rose 44.9% to $74 million and its net income was up 65.1% to $13.7 million. But its 19 cents a share EPS was 24% short of the 25 cents mean analyst EPS estimate.

Acme Packet remains confident of its future. After all, in June it signed a lease to boost its Bedford, Mass.-headquarters space -- where it does research and development, final test and assembly -- by 75% to 262,000 square feet. 443 of its 679 employees work there. And Acme Packet has already hired 70 workers and plans to add 117 more by the end of 2011.

But is Acme Packet boosting its return on capital? In a nutshell, yes. After all, it's producing positive EVA Momentum (essentially, growth in profit after deducting capital costs divided by sales), up a whopping 10% -- from 2009's EVA of minus $3.3 million to 2010's EVA of $10.4 million and 2009 revenues of $142 million.

But the stock is really expensive -- trading at a Price/Earnings to Growth (PEG) ratio of 2.15 (where 1.0 is considered fairly valued). Acme Packet's P/E is 91.7 on earnings expected to climb 42.6% to $1.27 in 2012.

And if insider selling is any indication, Acme Packet executives have concluded that it's time to lighten up on its shares. For example, CEO Andy Ory -- he owns around 4.3 million shares -- sold 90,000 shares on June 16. That was way more than the 50,000 he sold the previous month and he's been selling shares every month since the beginning of 2011.

This is a good company that investors have noticed. At this high a PEG, it would need to fall much further while outperforming expectations to make its stock a good investment. If Acme Packet's CEO thought it could do that, he might be buying shares rather than selling them.

Thursday, June 23, 2011

Will Investing in Fossil Revive Your Portfolio?

It's been a long time since I wore a watch. Why would I need one when I have a cell phone that tells me the time? Well, there are plenty of people that wear watches as a fashion accessory and they're buying watches from Fossil (NASDAQ: FOSL). Fossil has brought new life to a product category that I thought would go the way of the dinosaurs. Does that mean it will put pep in your portfolio?

Fossil sees itself as a fashion accessories company rather than a time keeper. It sells men's and women's fashion watches and jewelry, handbags, small leather goods, belts, sunglasses, footwear, cold weather accessories and apparel.

It operates globally through different channels -- wholesale, retail stores (department stores, specialty retail locations, specialty watch and jewelry stores, owned retail and factory outlet stores, and mass market stores), web sites, and third-party distributors.

Fossil has been growing steadily. For example, in the last year its sales reached $2.2 billion, up 31% and its net income of $275 million was 83% higher than the year before. Fossil's market capitalization is $7.1 billion -- up a head-slapping 185% in the last year.

Fossil's first quarter 2011 results were way ahead of expectations. Its 86 cents a share earnings were 30% ahead of Zacks Consensus Estimate of 66 cents. Fossil's sales were up 35.1% to $537.0 million reflecting strong double-digit sales growth across all of operating segments and major businesses -- including watch sales, growth in the jewelry category and the expansion of leather categories.

In short, Fossil is creating value for consumers and that is being reflected in its booming financial results in a global economy that is not quite as robust. But is Fossil also doing its part for shareholders? In a nutshell, yes. After all, it's producing positive EVA Momentum, up 7% -- from 2009's EVA of $5.9 million to 2010's EVA of $112.7 million and 2009 revenues of $1.5 billion.

But the stock is somewhat expensive -- trading at a Price/Earnings to Growth (PEG) ratio of 1.34 (1.00 is a reasonable PEG). Fossil's P/E is 27.42 on earnings expected to climb 20.4% to $5.55 in 2012.

Since the stock is a bit expensive, I would consider whether to buy this stock after a broad market correction. Events in Greece could easily provide such an opportunity. But global gloom is not slowing down Fossil's financial performance.

Wednesday, June 22, 2011

Should You Add SINA to Your Portfolio?

SINA Corp. (NASDAQ: SINA), operator of the third-most visited website and the Twitter-like Weibo service, enjoyed a 19% rise in its stock price Tuesday, the most in more than two years. But it lost money last year and its stock has fluctuated wildly. Should you add it to your portfolio?

SINA's most financial performance suggests the challenges facing the investor seeking to understand why it enjoys a $6.1 billion market capitalization. In the last year, SINA generated $481 million in sales and lost $28 million. But since 2002, SINA has grown its revenues at a 43% compound annual rate from $22 million.

Meanwhile its net income has fluctuated wildly -- driven largely by gains and losses on asset sales. In 2002, it earned $0.9 million -- with net income peaking in 2009 at $412 million -- only to post a loss of $19 million in 2010.

The good news about SINA is that it is targeting a large and rapidly growing market. According to its 2010 20-F filing with the SEC, 2010 ended with 19% more Internet users in China -- 457 million. And 98% of the Internet users in China have access to broadband. Moreover, the number of mobile phone users in China increased 15% to 859 million at the end of 2010 and mobile users with 3G capabilities grew 282% to 47 million.

But SINA has an odd corporate structure. For example, its balance sheet includes very different assets -- such as China Real Estate Information Corporation (CRIC). CRIC's value is declining because its business is slowing down and in 2010, SINA took a $128.6 million charge to write down the value of its investment, according to SINA's 20-F. As the Chinese government raises capital requirements and interest rates to slow down the economy, the Chinese real estate market could slow down and that could further impair CRIC's value. 

SINA appears to be in no danger of imminent bankruptcy. Its cash balances have been rising steadily -- from $363 million in 2006 to $882 million in 2010 -- and it has no debt. And it does have a valuable asset in its 140-million-user Weibo -- since Twitter is blocked in China and SINA plans to introduce an English language version by the end of 2011.

Nevertheless, there does not appear to be any obvious reason why SINA popped 19% yesterday. This volatile stock behaves as though it has fairly thin trading and that a big volume buyer can move the stock price dramatically.

Since its April 2000 IPO at $20 a share, the stock has risen at a compound annual growth rate of 14.9% to $92. This is nothing to get excited about. But the scariest thing about SINA's stock is its volatility -- for example, its all-time high was $143 in April 2011 -- it has since lost 36% of its value.

That may have had something to do with its first quarter 2011 financial performance. That's when SINA reported a $15 million profit, down 39% from the year before -- while its adjusted earnings per share fell to 25 cents -- two cents below the EPS expected by analysts that Dow Jones Newswires surveyed.

Adjusted revenues of $95.5 million were up 19% but came in $4 million below analysts' forecasts. Moreover, SINA forecast disappointing second quarter revenues of between $112 million and $115 million -- analysts predicted $115 million.

Analysts believe that SINA will post future profits. And its Price/Earnings to Growth (PEG) ratio of 1.39 -- a forward P/E 69.7 on earnings forecast to grow 50% to $1.32 in 2012 -- is fairly expensive.

SINA's risks look like they outweigh its rewards. I would be wary of buying it.

Tuesday, June 21, 2011

Will Caterpillar Help Build Your Net Worth?

Caterpillar (NYSE: CAT) dealers just reported that their May 2011 engine sales spiked 21% from the previous year. Can buying the stock of this world leader in construction equipment boost the value of your portfolio?

Caterpillar makes construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives. It makes construction and mining machines, builds and sells the engines that power them, and finances and insures their purchase and operation.

And Caterpillar makes a hefty profit from all this. It generated $47.3 billion in revenues, up 32% in the last year and $3.7 billion in profit up 202% . Moreover, in so doing Caterpillar has built up a $63 billion market capitalization -- up 49% in the last year. The biggest financial risk for Caterpillar is its 2.34 debt to equity ratio -- far above the industry's 1.89.

Caterpillar's recent spike in engine sales is compelling -- but it masks a slowdown in growth over recent months and wide variations in growth by engine type. For example, Caterpillar's total engine demand grew faster in February 2011 (31%), March 2011 (45%), and April 2011 (25%).

Moreover, its 21% May 2011 growth by engine type indicates shrinking demand for some kinds of engines and rising demand for others. For example, sales were up for 45% for electric power, up 32% for industrial, and up 12% for petroleum and down 27% for marine engines. This suggests that a slowdown in emerging markets -- like China and India which use these engines for electric power and industrial applications -- would be bad for Caterpillar investors.

So far in 2011, Caterpillar's results have been tremendous. It first-quarter earnings of $1.23 billion, or $1.84 a share, were up 429% from $233 million, or 36 cents a share, a year earlier. Sales spiked 57% to $12.95 billion. Caterpillar raised its forecast for 2011 earnings, projecting profits would exceed its previous record set in 2008.

But Caterpillar is not earning enough to repay the providers of its capital. Although it's producing positive EVA Momentum, up 7% -- that represents an improvement over a bad 2009 while problems remained in 2010. That's because Caterpillar had negative EVA in both years -- ($3,952) million in 2009 and ($1,690) million in 2010 on 2009 revenues of $32.4 billion.

And Caterpillar's PEG of 0.57 makes it look seriously under-valued -- its P/E is 17.4 on earnings expected to climb 30.5% to $9.05 in 2012.

Caterpillar is a huge consumer of capital but if it keeps growing profits as quickly as it has recently, it should out-earn that cost of capital in the next year or two. If demand slows down in Asia though -- look out below.

Monday, June 20, 2011

Should You Short First Solar?

First Solar (NYSE: FSLR) is attracting the attention of short sellers -- traders who bet on a tumbling stock price by borrowing the shares from a broker, selling them, and hoping to profit by repaying the borrowed shares by buying them back at a lower price in the open market. At 23%, First Solar's shares short as a percent of total shares outstanding is at a record high. Should you bet that First Solar will fall?

To make that decision, you ought to decide whether the risks of shorting First Solar are less than the upside. And there are plenty of risks to shorting a stock. The first is that if your short bet goes bad and the price of the stock rises above where it was when you sold it, you need to write a check into your margin account with the broker. And if that stock price rises enough, the broker could force you to immediately repay your loan by buying back the stock and taking a loss.

First Solar is a $2.5 billion (most recent years' sales) Tempe, Ariz.-based maker and seller of so-called photovoltaic (PV) solar power systems -- the world's largest such manufacturer. Those systems include solar modules that convert sunlight into electricity. First Solar sells those components to project developers, system integrators, and renewable energy project operators.

Not only is First Solar big, but its sales have been growing fast, it's profitable, it has a low-risk balance sheet, and its stock is reasonably priced relative to its earnings growth. Specifically, First Solar's sales have been growing at a 122% annual rate for the last five years and it earned $608 million in profit during the last year, a 24% net profit margin.

The $10.4 billion market capitalization company has virtually no debt (a debt/equity ratio of 0.04 way below the industry's 0.3) -- which means that it is in no danger of running out of cash soon -- and it trades at a reasonable Price Earnings to Growth (PEG) ratio of 1.11 -- its P/E is 17.3 and its earnings per share are expected to grow 15.6% to $10.89 in 2012.

So why are short sellers piling in to First Solar? They believe that supply vastly exceeds demand and that will continue to produce price cuts that will cause revenues and profits to plummet. For example, according to Bloomberg, Italy and Germany slowed development of solar projects even as two of the world's solar-cell makers by capacity, China’s JA Solar Holdings Co. and Suntech, were leading "an industrywide expansion of factory capacity."

New Energy Finance estimates that this will lead to about 33% slack industry productive capacity. That's because those new manufacturing lines will account for 9.5 gigawatts of production going online by the end of 2011 -- leading to an industry total of 41.5 gigawatts -- while demand is not likely to go any higher than 28 gigawatts.

This is not a huge surprise to investors though -- an index of solar stocks lost quarter of its value since reaching a 13-month high on Feb. 18. And solar cell makers have cut prices about 21% so far in 2011 according to Bloomberg.

But it's not like this bad news is a surprise. In fact, there seems to be a Wall Street bias against solar. One curious story is that on May 4, 2011 CNBC reported on the air that First Solar missed earnings expectations. But in fact, First Solar beat expectations by 15% -- nevetheless, its stock fell 10%, according to Motley Fool.

Sure, there is excess capacity in the industry but this comes as no surprise to investors. Meanwhile, First Solar is expected to be profitable and has virtually no debt, putting it at no risk of near-term bankruptcy. Hence, the risk of a short squeeze -- where short sellers are forced to buy the stock to repay the shares they borrowed from their brokers -- is pretty high.

All it would take is earnings that are better than diminished expectations. The balance of risk and return from shorting First Solar shares suggests that you might not want to join those short sellers just now.

Friday, June 17, 2011

As Boeing Boosts Sales Forecast, Should You Buy?

Boeing (NYSE: BA) boosted its long-term forecast of aircraft sales at the Paris Air Show. If Boeing's forecast is accurate, its sales should rise above previous expectations. Should you buy its stock?

The $68 billion (2010 sales) Boeing boosted its expectations for industry sales over the next 20 years by 8.5% on Thursday. Instead of the total of 30,900 industry wide aircraft it expected last July to be sold through 2030, it now expects that figure to total 33,500. Given price increases, those new orders will add $4 trillion to its sales -- 11% more than Boeing's July forecast of $3.6 trillion.

Boeing's brighter forecast reflects an optimistic view of global growth. Randy Tinseth, vice president for marketing at Boeing’s commercial airplanes division told the New York Times that growth would come from strong air travel demand now and positive long-term trends. As Tinseth said, “Not only is there a strong demand for air travel and new airplanes today, but the fundamental drivers of air travel — including economic growth, world trade and liberalization — all point to a healthy long-term demand.”

Boeing expects 3.3% average global GDP growth over the next 20 years with the fastest growth in China and India (up 7% a year each). Moreover, by 2030 Boeing forecasts 5% global air traffic growth with the fastest air traffic growth in the Asia-Pacific region (up 7% a year) and the slowest in North America -- up 2.3% annually). Moreover, Boeing expects passenger traffic to nearly triple while cargo traffic will more than triple by 2030.

This will translate into different levels of aircraft demand growth around the world, according to HeraldNet. Boeing expects 20 year demand growth by region as follows:
  • The Asia-Pacific 34%
  • Europe 23%
  • North America 22%
  • Latin America 8% 
  • Middle East 8%
Most of the new sales will come from smaller planes. Boeing expects 70% of the growth to be in sales of single-aisle planes like the 150-to-200-passenger Boeing 737 and Airbus A320. Twin-aisle wide bodies like Airbus’s planned A350-XWB and the Boeing 787 Dreamliner would account for another 22% of the growth.

Boeing's ability to capture that growth in twin-aisle demand will depend on its ability to deliver its oft-delayed 787 -- the 865-order, $139 billion backlog for the 250- to 330-seat aircraft -- about which I wrote in You Can't Order Change. (Boeing's stock has fallen 30% from its peak of $105 in Sept. 2007 when I signed that book contract.) Since the book's 1998 publication, Boeing has delayed the 787 seven times due to technical problems, a strike, and more generally the problems of too much outsourcing.

Boeing CEO Jim McNerney recently acknowledged these outsourcing mis-management problems about which I wrote in 2008. As he said at its annual investor conference, "What you end up realizing is, you need more cost to supervise outside factories outweighing the benefits of outsourcing design and manufacturing on the 787." In January, the 787's $12 billion cost was 120% over budget.

Boeing also faces problems in opening up a 787 production line in non-union South Carolina. Boeing set up the plant there because workers do not need to join a union in order to work in a plant in that state. This would give Boeing a place to continue making 787s if its unionized Washington-state plant workers went on strike. The House of Representatives is now taking up a National Labor Relations Board complaint against Boeing, according to AP.

While Boeing's future is the key to valuing its shares, its short-term performance also matters. And on that front, Boeing beat expectations and has maintained its guidance for lower than last years' earnings per share (EPS) in 2011. Boeing's first-quarter profit was $586 million, or 78 cents per share, 9% ahead of analysts' expectations according to Thomson Reuters I/B/E/S. Its revenues were down 2% to $14.9 billion, partly because it delivered fewer 777s than in the previous year.

Boeing stuck with its 2011 outlook of sales between $68 billion to $71 billion and EPS between $3.80 and $4. Those 2011 earnings would be below 2010's in which Boeing earned $4.45 per share on revenue of $64.3 billion.

Boeing is doing its part for shareholders. After all, it's producing positive EVA Momentum, up 2% -- with a great turnaround from 2009's EVA of negative $1 billion to 2010's EVA of $462 million and 2009 revenues of $64.3 billion. And Boeing's PEG of 0.56 makes it look under-valued -- its P/E is 16.3 on earnings expected to climb 29% to $5.33 in 2012. And the earnings forecast does not reflect Thursday's 8.5% boost to Boeing's 20 year industry revenue forecast.

With its 2.27% dividend yield, now would not be a bad time to think about adding Boeing to your portfolio.

Thursday, June 16, 2011

With Family Scion To Run For President, Should You Buy Stock in Huntsman Corp.?

Former U.S. Ambassador to China, Jon Huntsman is poised to announce his run for the presidency in 2012. Thanks to his family's chemical company, Huntsman (NYSE: HUN), he has never wanted for campaign funds. And with a growing portion of that company's jobs going to China, what's good for Huntsman shareholders may not be good for his presidential bid. Should you hold your nose and buy its stock?

The $4.2 billion market capitalization, Huntsman makes chemicals around the world -- its most famous products are its polystyrene-dozen-egg container and the Big Mac clamshell. Headquartered on 500 Huntsman Way in Salt Lake City, Jon Huntsman (the former Ambassador's father), and the company's Executive Chairman, likes having his name on things. For example, the University of Pennsylvania's Wharton School named its now-main building, Jon M. Huntsman Hall, after him for giving most of the $140 million needed to build it.

Huntsman's China revenues rose in the years the Ambassador served the man whose office he aspires to occupy. According to Bloomberg's analysis, Huntsman's revenue in China increased 57%  from 2009 to 2010 -- 9.5% of corporate revenue, almost two decades after the company first started doing business there. 

The Ambassador's brother, Peter, is CEO. As Bloomberg reported, on June 8th, Peter boasted, “We now employ more people between China and India than we do in North America, which is really quite phenomenal when you consider that about 90 percent of our associates 10 years ago were in North America.”

At $17.58, Huntsman stock trades 24% below its February 2005 IPO price of $23. And on May 26, its Huntsman International unit agreed to pay $33 million to settle a lawsuit alleging it conspired to fix the price of urethane chemicals sold in the U.S. from 1999 through 2004, according to Bloomberg.

That does not resolve all of Huntsman's legal problems. According to its 2010 10K, the U.S. is investigating the company for potential violations of the U.S. Foreign Corrupt Practices Act -- records at the facility showed that employees of Huntsman's Indian joint venture paid Indian officials as much as $11,000 in the nine months in 2009 and early 2010.

Has all this background noise affected Huntsman's recent financial performance? Not at all. In the first quarter, Huntsman blew through expectations. Its net income of $62 million, or 26 cents per share, was a big improvement over its net loss of $172 million, or 73 cents per share, in the first quarter of 2010. Its adjusted EPS of $0.47 was 100% better than the 24 cents per share expected by analysts polled byThomson Reuters I/B/E/S. Not only that, but its revenues were up 28% to $2.68 billion -- 12.6% ahead of expectations.

The interesting reason for this boffo financial performance is a lesson in Economics 101. In many parts of its business, Huntsman is operating at full capacity and demand is strong. As a result, Huntsman is able to raise its prices more than the rise in the cost of its raw materials. As Gleacher & Co analyst Edlain Rodriguez explained to Reuters, "They did extremely well. Their facilities are running at full capacity. They're able to raise prices to offset costs and demand is extremely strong."

But in 2009 and 2010 Huntsman's cash flows fell far short of its cost of capital. In the last year, Huntsman has been creating negative so-called Economic Value Added (EVA). Bennett Stewart coined the term -- it's a number calculated as follows: EVA = Net Operating Profit After Tax - (Total Assets - Current Liabilities) x the Weighted Average Cost of Capital).

The best companies create value in excess of their cost of capital -- generating a positive EVA. But using the EVA measure, Huntsman is destroying value -- albeit at a less dramatic rate in 2010 than it was in 2009. Its 2010 EVA was negative $550 million, down 44% from its 2009 EVA of negative $986 million.

Huntsman could be in an awkward situation when it comes to repaying its debts. After all, at the end of 2010 it had $3.6 billion in long-term debt, double its $1.8 billion in equity -- making it far more leveraged than its industry (the chemical industry's debt to equity ratio is 0.9). And it must repay $519 million of that debt in 2011 -- fortunately, it had $966 million in cash at the end of 2010.

Is the market pricing all of Huntsman's financial risks and opportunities correctly? To think about that, we can look at its price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

Huntsman stock is reasonably priced -- trading at a PEG of 0.97. Its P/E is 18.9 and its earnings are forecast to grow 19.5% to $2.10 in 2012.

If Huntsman can keep doing better than expected, it may be worth a look. But I would avoid this equity at least until the dust has settled from the expected opposition research that will use publicity about the negative aspects of Huntsman's business operations to undermine the Ambassador's presidential hopes.

Wednesday, June 15, 2011

Should You Add Lorillard Stock To Your Portfolio?

Lorillard (NYSE: LO) popped nearly 12% Tuesday on hopes that federal regulators may back off demands to require it to pull menthol from its cigarettes. Is this a signal that you should add it to your portfolio?

What's all the fuss about? The Food and Drug Administration (FDA) is holding a July meeting at which it will discuss the future of menthol cigarettes. The FDA concluded that taking out menthol would benefit public health. The unexpected surprise was that the FDA said that changes are not imminent and could not happen until rule making, requiring public comment, had occurred.

This matters to Lorillard because 90% of its sales come from Newport, a menthol flavored premium cigarette. This delay means that Lorillard can keep selling its menthol-flavored cancer sticks. And selling Newports is a big business. In the last 12 months, for example, the $16.4 billion market capitalization company (up 54% in the last year), generated $6.1 billion in revenue and $1 billion in net income, up at five year average growth rates of 10.7% and 7.8% respectively.

Lorillard's recent financial performance has been solid. In the first quarter, its net income rose 6.9% to $248 million ($1.71/share) -- 9% above analysts' estimates of $1.57 -- from $232 million ($1.50/share) in 2010's first quarter. And its revenues rose 12.9% to $1.53 billion.

And Lorillard's ability to boost cash flow above its cost of capital is strong. In the last year, Lorillard has been creating so-called Economic Value Added (EVA) Momentum, a sign that the company is generating cash flows that exceeds the capital required to finance its operations. Bennett Stewart coined the term -- it's a number calculated by dividing the change in EVA [Net Operating Profit After Tax - (Total Assets - Current Liabilities) x the Weighted Average Cost of Capital)]/Beginning Period's Revenues.

The best companies create value in excess of their cost of capital -- generating a positive EVA momentum. The higher the EVA momentum, the faster management is creating value. And Lorillard's EVA Momentum is a solid 2%. This figure comes from subtracting Lorillard's 2009 EVA of $881 million from its 2010 EVA of $973 million and dividing the difference by its 2009 revenues of $5.2 billion.

Does the market fully recognize Lorillard's ability to create value -- making it too expensive to be worth adding to your portfolio? To think about that, we can look at their price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

Lorillard stock is fairly expensive, trading at a PEG of 1.63. Its P/E is 16.3 and its earnings are forecast to grow 10% to $8.50 in 2012. Even though its reported earnings have been beating expectations for the last five quarters, the extent of that upside surprise is fairly modest.

It looks like yesterday's pop priced in the value of the FDA's stay of Newport's execution. Too bad the same can't be said for Newport smokers. If that doesn't bother you, wait for a market dip to inhale this stock.

Tuesday, June 14, 2011

Is Youku Destined to Drop Further?

$2.8 billion market capitalization Youku (NYSE: YOKU) is China's version of Google's (NASDAQ: GOOG) YouTube. For some unknown reason, the SEC allowed Youku to sell American Depository Shares (ADS) -- each of which "represents 18 Class A ordinary shares" with a third the level of voting control as the Class B shares -- to U.S. investors. And since the beginning of 2011, those ADSs have lost 23% of their value. The so-called lock-up period, that keeps insiders from selling, has expired. And this may mean that insiders are dumping shares. Do they have further to fall?

Youku describes itself as "an Internet television company in People’s Republic of China."  It generates revenues by selling advertising to companies seeking to reach viewers of its 2,200 movie titles, 1,250 television serial drama titles and "231,000 hours of other professionally produced content, including 194 variety shows." Those viewers include 203 million monthly visitors from homes and offices and 61 million monthly visitors from Internet cafes.

And Youku has a unique corporate structure. It's a holding company based in the Cayman Islands but headquartered in Beijing. That holding company owns Youku, that changed its name from iVerge Internet in Nov. 2005, and Brilliant Jet, an advertising agency. This structure makes it hard for U.S. entities to sue, it does not pay income taxes to Chinese or Cayman Islands authorities, and is not subject to U.S. taxes (although there's a risk it could be).

Last week, the lock up period on Youku's ADSs expired -- making 19.6 million ADSs available from insiders, which will add to its 30 million ADS float.  Despite that increase in supply and a plunging price, the company sold 12.31 million ADS at $48.18 per ADS in late May.

Is there any link between Youko's ability to sell ADSs and its financial performance?

An examination of its form 20-F, it looks like a 10K, reveals a company that's growing and losing lots of money. That's because the cost of the bandwidth to stream its videos and the cost of licensing that content -- a cost that grew at over 200% in 2009 and over 100% in 2010 -- eats up all its advertising revenues (they grew 364% in 2009 and 151% in 2010. And Youku's capital expenditures further siphon cash out of the company.

Based on this, it's not clear whether investors can rely on its financial reports. But a look at those reveals that without its ability to sell stock -- led by Goldman Sachs (GS) -- it would be burning through cash fast. That's because it reported $59 million in sales and a $31 million net loss. Without the $217 million in proceeds from its IPO, this company would be gasping for cash.

I am not sure whether anyone who bought these ADSs actually read Youku's financial filings. But it looks like this company's stock is floating on thick cloud of hype.

Monday, June 13, 2011

Is Qualcomm good for your portfolio?

Qualcomm (NASDAQ: QCOM) -- a designer and builder of digital wireless telecommunications products and services -- is one of the few public companies to enjoy a successful father to son transition. Founder Irwin Jacobs' son, CEO Paul Jacobs, envisions a future of sensor networks (SN) -- seeking to implement an idea I wrote about in 2005. But does this mean Qualcomm stock will make you richer?

In 2005, I wrote about Sensor Networks (SNs) as a possible technology in which companies might invest to boost their productivity. Back in 2003, Wal-Mart Stores Inc. (NYSE: WMT) was trying to create a kind of SN through an initiative announced to require its top 100 suppliers to install Radio Frequency Identification (RFID), by Jan. 1, 2005. RFID tags are small, 25-cent components including a chip, antenna and product information that Wal-Mart could track through in-store and in-warehouse RFID signal-reading machines.

While Wal-Mart didn't meet its January 1 deadline, the benefits--reduced supply chain costs, shelves stocked with what consumers want and less of the rest, as well as diminished theft--make the Wal-Mart initiative an SN test case. And it was still working out the kinks by 2009.

SNs may also help with building automation, industrial monitoring and perimeter security. Berkeley, Calif.-based Dust Networks' SmartMesh technology deploys sensors that collect and transmit physical data for such industries. But developers must address big challenges before SNs become the "next big thing."

RFID and SNs create huge amounts of data, generated by tracking many items' locations over time, explains Jeannie Ross, senior researcher at MIT's Center for Information Systems Research (CISR). In 2005, Ross told me that she believes that SN developers must find the right application and the analytical tools to sift nuggets of insight from torrents of data. A technically feasible application might not make business sense. For instance, a retailer could put an RFID tag on a $1 tube of toothpaste to signal the retailer when the consumer emptied the tube, but this would probably not profit the retailer.

Before SN data can pass across corporate perimeters, settlement systems must be developed, argued Kim Perdikou, Juniper Networks' (NASDAQ: JNPR) CIO. For example, if an SN data packet passes through a local telephone company, a cable broadband provider and a private wireless carrier, the participants must agree how to hand off the data and allocate and charge the relevant costs.

Furthermore, SN developers must protect data privacy, noted Bill Dally, Stanford University Computer Science chair. For motorists in traffic, real-time data on the position and speed of vehicles ahead of them on the highway could be more useful than radio traffic reports. But unless an "anonymizer" protects motorists' identities, people worried about their privacy would likely oppose the system.

International Business Machines' (NYSE: IBM) On Demand Computing initiative combines the SN and SW to create what Gary Cohen, general manager of IBM's Pervasive Computing referred to the use of computers in everyday life, including PDAs, smartphones and other mobile devices. It also refers to computers contained in commonplace objects such as cars and appliances and implies that people are unaware of their presence. Group, calls "a more democratized, inclusive way of thinking about technology that brings together people throughout an enterprise's departments and across its value chain."

In 2011, SN's full potential has yet to be achieved. But Qualcomm's CEO Paul Jacobs envisions a world in which sensor networks proliferate and part of the company's $2.5 billion research budget is going to realize that vision. According to the New York Times, Jacobs -- who has a PhD in Electrical Engineering from U. of California, Berkeley -- enjoys talking about SNs.

Jacobs has a different view of SNs. He calls it "the Internet of things" -- in which "TVs, dishwashers, running shoes, blood glucose monitors, picture frames, heart defibrillators and even Band-Aids have tiny chips or sensors that transmit information and communicate with mobile devices like smartphones and tablets," according to the Times.

Until Qualcomm finds a way to profit from realizing that vision, the company's operating performance has been solid. In its 2011 second quarter ending in March, its net income was $999 million and its non-GAAP earnings were 86 cents a share -- six cents better than expected -- on a revenue of $3.87 billion -- $250 million ahead of expectations. And Jacobs noted, "We are raising our revenue and earnings guidance for the year as the demand for smartphones across an array of geographies and tiers continues to grow," according to ZDNet.

In the last year, Qualcomm has been creating so-called Economic Value Added (EVA) Momentum, a sign that the company is generating cash flows that exceeds the capital required to finance its operations. Bennett Stewart coined the term -- it's a number calculated by dividing the change in EVA [Net Operating Profit After Tax - (Total Assets - Current Liabilities) x the Weighted Average Cost of Capital)]/Beginning Period's Revenues.

The best companies create value in excess of their cost of capital -- generating a positive EVA momentum. The higher the EVA momentum, the faster management is creating value. And Qualcomm's EVA Momentum is an impressive 9%. This figure comes from subtracting Qualcomm's 2009 EVA of ($756 million) -- it "destroyed value" that year -- from its 2010 EVA of $132 million and dividing the difference by its 2009 revenues of $10.4 billion.

Does the market recognize Qualcomm's ability to create value making it worth adding to your portfolio? To think about that, we can look at their price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

Qualcomm stock is cheap -- trading at a PEG of 0.70. Its P/E is 23.7 and its earnings are forecast to grow 34% to $2.77 in 2011.

If Paul Jacobs can realize his vision of an Internet of things, Qualcomm stock could be a valuable addition to your portfolio.

Friday, June 10, 2011

Is Citigroup Stock Dirt Cheap?

Citigroup (NYSE: C) -- the $110 billion market capitalization financial services behemoth whose stock trades 92% below its May 2000 split-adjusted-high of $466 -- decided to reveal that hackers broke into its computers and got access to confidential information on 200,000 of its credit card customers. While this is certainly bad news for them, should it keep you from buying Citigroup stock?

Citigroup found out that these customer accounts had been hacked in May but just started letting customers know about it this month. But the New York Times reports that the information on each cardholder ought not to inconvenience those cardholders much.  Although the thieves got customer names, card numbers, addresses, and e-mail details they did not steal customers' Social security numbers, expiration dates and the three-digit code on the card's back.

Although this news is bad for Citigroup, it can take comfort in knowing it's not alone when it comes to hacking into electronic accounts. Identity Theft Resource Center reports that since 2005, financial services companies have publicly disclosed 288 publicly breaches that exposed no fewer than 83 million customer records. 

Not only that, but the cost of fraud has dropped dramatically in the last 19 years. In 1992, Nilson Reports said banks lost 15 cents to fraud for every $100 charged. Since 2005, that figure is down 66% to 5 cents for every $100. While credit card companies set up security standards in 2005, "compliance with those rules has been mixed," according to the Times.

Despite this bad news for Citigroup, it is unclear how many of its credit card customers will bolt to another issuer since there does not appear to be an obvious provider that is 100% impervious to hackers.

Meanwhile, Citigroup, the $77 billion (2010 revenues) that completed a 10-for-1 reverse stock split on May 6, reported slightly better than expected first quarter results. Its $3 billion net was down 32% from the year before, but its 10 cents a share EPS beat by a penny 21 analysts surveyed by Bloomberg.

The report contained a mixture of good and bad news. The good news was that this was Citigroup's fifth profitable quarter in a row and its losses from bad loans fell 25% as fewer customers missed payments  than the year before's first quarter. The bad news was that profits in its trading and investment-banking businesses tumbled almost 50% and revenue was down in all but one of its six business units.

Does Citigroup's profit mean it's time to buy its stock? To think about that, we can look at their price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

At a PEG of 0.45, Citigroup looks cheap. Citigroup's P/E is 12.2 and its earnings are forecast to grow 27% to $5.37 in 2012 after growing 21% this year. If Citigroup can keep beating analysts' expectations, its stock price has a chance to rise from its current low level.

Thursday, June 09, 2011

Can You Profit By Betting Against RenRen?

RenRen (NYSE: RENN), a Chinese social network, is down 42% since its early May 2011 Initial Public Offering (IPO). The day it went public, May 4, the stock peaked at $18.01 -- and since then it has tumbled to $10.51. Can you profit from a short bet?

You have to get nervous when a young company changes its name. After all, RenRen, registered in the famous tax haven, the Cayman Islands, used to be known as Oak Pacific Interactive. RenRen describes itself as "a social networking Internet platform in China." Its revenues come from advertising and "Internet value-added services (IVAS)." In the last year, $4.1 billion market capitalization RenRen generated $77 million in revenues, up 64%, and lost $63 million, 7% less than the year before.

In thinking about whether to sell this stock short -- a bet that involves borrowing the shares from a broker, selling them at the market price, and then repaying the share loan by buying them back in the open market, it is important to consider whether the company has a good chance of going bankrupt. And since RenRen has no long-term debt, the answer is probably not.

One area worth looking for problems is in RenRen's accounting. A Stanford researcher I spoke with this week told me half tongue-in-cheek that Chinese companies have three sets of books -- one that reflects their real results, another to keep from paying taxes, and a third for U.S. investors. And that third set of books often inflates the actual results of the company.

Research into so-called reverse mergers with Chinese companies reveals that this is not always a joke. In such a reverse merger, a moribund, but publicly traded U.S. company buys a Chinese company and changes its name to the acquired company. The purpose is for the Chinese company to get access to U.S. investors without going through the process of getting its shares registered with U.S. regulatory authorities.

There are plenty of such reverse mergers. As BusinessWeek found in January, such reverse mergers were 94 companies with market capitalizations of between $50 million and $1 billion that trade an average of at least 50,000 shares daily, with a total stock market value of more than $20 billion.

And there are plenty of such reverse mergers where the U.S. financial results are much better than the actual ones. An example, according to BusinessWeek, is China Sky One Medical (NASDAQ: CSKI), a maker of products such as "magnetizing" hemorrhoid ointments and patches that would "dispel fat." Sky One, according to its annual report filed just a few days earlier, was selling out of its inventory every seven days -- much faster than one investigator, John Bird, thought possible.

But Bird found that Sky One's report on its financials to the Chinese regulatory authorities, SAIC, was much different than what it reported to the SEC. Specifically, Sky One reported to SAIC that its operating unit, Harbin Tian Di Ren, had 2008 sales of about $1 million while reporting $59.7 million in 2008 sales to the SEC. Bird made a huge profit selling Sky One's shares short.

Although RenRen has not done a reverse merger, its U.S. prospectus raises important questions about its accounting. For example, its auditor pointed out that RenRen had material weaknesses in its internal controls -- including a lack of personnel with adequate U.S. GAAP accounting expertise and inadequate procedures for control of the investing of its surplus cash. The upshot is that there is no certainty that RenRen's financial statements are accurate.

Among the curious parts of RenRen's financial reporting -- one sticks out. Thanks to a $73 million "change in the fair value of warrants" -- a warrant is similar to an option that gives the holder the right, but not the obligation, to buy shares -- in 2010 RenRen went from burning through cash to reporting in increase in cash. RenRen issued these warrants to SOFTBANK CORP. in April 2008 and amended in July 2009 in connection with its sales of series D preferred shares.

As it turns out, this $73 million is based on management's very convenient set of assumptions plugged into a financial model for the valuation of its so-called ordinary shares. If you have the stomach for it, these calculations are mentioned in its prospectus -- but despite a plethora of details about the assumptions -- there is still not enough detail to decide whether these assumptions are accurate.

The prospectus also highlights some enormous regulatory risks. The Chinese government could shut down RenRen's business if it finds that it is not complying with a law regarding its corporate structure (operating in China while being registered in the Cayman Islands); the U.S. government may decide that it should pay U.S. taxes, the Chinese government could penalize it for causing gaming fatigue for RenRen users who play its games for more than three hours.

Can you profit from selling RenRen shares short? I cannot find a smoking gun although, according to Cody Willard, "Renren has already had to correct numbers in their IPO prospectus and has had a board member resign already because of accounting issues at another company where he was on the board.”

If you're willing to bet that RenRen has sufficiently poor accounting that its value is overstated, then you should considering shorting its shares. Otherwise, I would suggest avoiding the stock.

Tuesday, June 07, 2011

Should You Follow the Waltons into Wal-Mart?

The heirs of Sam Walton, Wal-Mart Stores (NYSE: WMT) founder, are about to own over 50% of its publicly traded shares. That still leaves some for you. Should you buy them?

Thanks to a $15 billion share buyback program, Walton's heirs will soon control just over 50% of Wal-Mart stock. After Walton's 1992 death, his family controlled 38% of the stock until the mid-2000s. But a series of big stock buyback programs beginning in 2003 push the heirs' stake higher -- to 43% in 2008, 49% in June 2011; and soon to top 50%.

But owning Wal-Mart stock divides into different eras -- the Thrill Years and the Boring Years. During the Thrill Years, Wal-Mart was a great stock to own -- from its 1978 initial public offering at a split-adjusted $0.08, Wal-Mart rose to $67 in December 1999, growing at a compound annual rate of 37.8% -- five times the rate of the average stock. Since the dawn of the 21st century, the Boring Years, the stock has fallen about 20% and -- with the exception of a nice run-up in 2007 -- gone nowhere. 

In the last decade, Wal-Mart has gotten much bigger but its stock has not followed suit. For example Wal-Mart sales and profits have grown 105% and 141%, respectively to $419 billion and $15.4 billion. Yet in the last decade, Wal-Mart's market capitalization has fallen 15% from $221 billion to $187 billion as the number of shares outstanding has declined 22% from 4.5 billion to 3.5 billion.

Why is the market not thrilled with Wal-Mart's financial performance? It could be that Wal-Mart has hit the limit of rapid growth that's imposed by a company reaching a certain size. For example, in order for Wal-Mart to grow at 15% a year, it would need to add $63 billion in sales in the next year -- that is like creating a new PepsiCo (NYSE: PEP) -- that booked $60 billion in 2010 sales -- every year. But for the last five years, Wal-Mart has been growing sales and profits at a 6% annual rate.

The difficult reality is that Wal-Mart cannot grow much faster. In theory, there should be enormous growth opportunities in large, developing nations that are growing much faster than the U.S. But Wal-Mart has not been able to penetrate these markets sufficiently -- it does have 338 shops in 124 Chinese cities, with 90,000 employees and annual sales of $7 billion. But that's less than 3% of its U.S. sales, according to The Economist.  And it is struggling to get a joint venture with India's Bharti -- India (population 1.1 billion) prohibits non-Indian companies from operating store fronts -- off the ground.

The second problem Wal-Mart faces is that its capabilities limit its ability to grow. This was not always the case. As I wrote in my book, Value Leadership, in the 1990s, Wal-Mart was able to use its skills to expand from discount retailing into pharmacies and grocery retailing. That's because its skills at keeping each stores' shelves stocked with items that customers wanted to buy and using its scale to negotiate volume discounts were directly applicable to building winning positions in new industries.

But when it came to expanding globally, Wal-Mart's performance was irregular. It failed in Germany but had more luck in Mexico with Wal-mart de Mexico (PINK: WMMVY). And then there's been the growth in e-commerce -- a development that was naturally difficult for Wal-Mart to exploit since management was more concerned about cannibalizing its stores than outcompeting the likes of Amazon (NASDAQ:AMZN) in delivering consumer e-commerce service. The result is that Wal-Mart's e-commerce sales are tiny -- it has not disclosed them recently but they may be about $2 billion.

Wal-Mart's first quarter performance reflects its now-plodding nature. On May 17, Wal-Mart reported a 4.4% revenue hike to $103.4 and a 3% rise in net income due to strong international sales -- that account for 26% of the total -- and tighter cost controls. But its same-store sales fell for the eighth straight quarter. It earned $3.39 billion, or 97 cents per share for the quarter ending April 30 -- beating analysts' expectations by 2 cents. That was better than 2010's first quarter earnings of $3.3 billion, or 87 cents per share.

Does Wal-Mart's ability to beat these modest expectations mean it's time to buy its stock? To think about that, we can look at their price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

Wal-Mart's PEG of 1.27 is a little pricey. It trades at a P/E of 12.53 on earning forecast to grow 9.9% to $4.90 in 2012. But it has been growing at about a third of the rate in the most recent quarter with economic headwinds slowing down growth in the U.S.

Despite recent good news on international growth, I don't see that as a sufficient catalyst to drive up its stock price.

Monday, June 06, 2011

Is Yahoo Undervalued?

Bloomberg reports that tech stocks are more undervalued than they've been since 1998. Moreover, hedge fund honcho, Greenlight Capital's David Einhorn, disclosed that he bought a big chunk of Yahoo (NASDAQ: YHOO) in April 2011. Should you follow Einhorn into Yahoo?

The case for investing in technology stocks is clear -- the value that investors assign to technology stocks has tumbled as their expected profit growth accelerates. Since stocks peaked on Feb. 18, tech stocks have lost $190 billion in market value, a 7% drop -- and they now trade at 9.3 times reported earnings before interest, taxes, depreciation and amortization (EBITDA), 1.3 times the index’s multiple -- the lowest ratio since at least 1998.

But analysts expect tech earnings to roar upwards. In 2011, technology earnings are expected to rise 35% faster than the S&P 500 index -- 24% vs. 17% for the S&P 500. This means that tech stocks trade at a P/E of 12.8 compared to 13.1 for the index.

Does this mean you should invest in technology stocks? To think about that, we can look at their price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

And on that basis, tech stocks are cheap -- trading at a PEG of 0.53.

Prospects for continued demand growth for technology look compelling. In the first quarter, despite anemic 1.8% GDP growth, investment in technology climbed 11.6%. And executives are boosting computer and software spending 10% in 2011, about four times faster than U.S. GDP.

Einhorn announced in April that he bought Yahoo shares because, according to Market Folly, he "likes the company's net cash position and [its[ 40% stake in Alibaba Group as a valuable asset."

But for its most recently quarterly report, Yahoo reported down earnings though not as bad as expected. In April, Yahoo said its first quarter profit ending in March 2011 fell 39% to $223 million from the previous year to 17 cents a share while its net revenue fell 6% to $1.06 billion. It beat EPS by a penny and its revenues fell $10 million short according to analysts that FactSet Research polled.

And Yahoo's guidance for its second quarter ending June 2011 were consistent with expectations. In April, it forecast that its revenue excluding traffic acquisition costs would range between $1.08 billion to $1.13 billion. Analysts had been expecting $1.1 billion.

But since then, Yahoo shareholders have faced bad news. On May 26, IDC reported that Google (NASDAQ: GOOG) took first place from Yahoo in U.S. display advertising market share. Specifically, in the first quarter of 2011, Google's share of the U.S. display ad market rose to 14.7% shrank from 13.6% to 12.3%.

So after Yahoo's stock has fallen 5.7% in 2011, is Einhorn right to buy it? Yahoo's PEG of 1.04 -- its P/E of 16.5 on earnings growth of 15.8% in 2012 to $0.91 -- suggests the stock is reasonably valued. But given its history of beating expectations by about 16% over the last four quarters, there is some catalyst for a price rise.

I just don't think the cost cutting that lets Yahoo boost earnings is enough to justify getting too excited about the upside potential in a company that's losing market share.