Tuesday, May 31, 2011

Does it Pay to Put MetLife in Your Portfolio?

MetLife (NYSE: MET) reported strong earnings in May but its stock has been down 3% so far this year. Should you add MetLife to your portfolio?

MetLife is America's largest life insurance company. It sells a broad range of insurance and savings products -- including insurance, annuities and employee benefit programs -- to 90 million customers in 60 countries. In the last year, MetLife's revenues of $55.4 billion have grown at a 28.4% rate and its net income of $2.7 billion is up 210%.

Its stock price has been all over the map. It peaked in October 2007 at $71 and bottomed out in March 2009 at $12.22. Since then, it has climbed 260% to almost $44. This suggests a very important lesson for investors -- sometimes it makes sense to buy when everyone else is selling as they were when stocks bottomed out a bit over two years ago.

MetLife did well in the first quarter. Its $830 million in first quarter net income was 3% above the year earlier's net and its $1.33 in operating earnings beat Thomson Reuters I/B/E/ expectations by 5.6%. By purchasing life insurer Alico from AIG in a $16.2 billion deal in late 2010, MetLife's operating profit climbed 64% through the resulting expansion of its "footprint in Asia, Europe and Latin America," according to the Wall Street Journal.

MetLife's domestic business also did well. Its U.S. operating earnings rose 15% based in part on strong underwriting results in its group life-insurance business and its variable annuity sales rose 41% to a record $5.7 billion.

Some -- including M.D. Sass, reports the New York Times -- thought that the March 11 Japan earthquake was an opportunity to buy MetLife shares. That's because MetLife was among the most heavily exposed U.S. insurers to the Japanese market. But in May, MetLife forecast a relatively modest claims exposure in Japan ranging between $45 million and $65 million. Since then and May 27, MetLife's stock went up and down and now sits 4.2% below where it was the day before the Japan earthquake.

Is M.D. Sass right that you should add MetLife to your portfolio? 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.

At a PEG of 1.33, MetLife is not exactly a cheap stock. Its P/E of 15.4 compares to earnings growth of 11.6% to $5.82 in 2012. If you are determined to buy the stock, you can certainly make the case that the 2012 estimate is low -- after all MetLife EPS grew 19% in 2011 and its more recent quarter did feature some strong earnings growth.

At its current price, I would wait for a better entry point for MetLife. It's a very big company that is growing aggressively and its stock has attracted some big name investors. But it looks like it will take a catastrophe that's more damaging to MetLife's perceived investment prospects to make its stock cheap enough to attract value investors.


Friday, May 27, 2011

Should Your Portfolio Get to Know Cognizant?

Cognizant Technology Solutions (NASDAQ: CTSH) builds computer systems for companies in a unique way. Its business analysts work with clients from offices in the U.S. and other company headquarters countries while its coders write software in India. The result has been rapid growth and high profitability. Should you add Cognizant to your portfolio?

Cognizant's financial performance over the last five years has defied the general economic doldrums in the U.S.,where it's based. In the most recent 12 months, its sales were $5 billion, growing at a 39% five year average rate while its net income accelerated at a 35% annual rate to $791 million. Cognizant's market capitalization of $22.9 billion has skyrocketed 54% in the last year -- more than twice the S&P's 22% gain.

Cognizant plays in a large market that's growing fast. According to India's National Association of Software & Services Companies (Nasscom), the market for information technology outsourcing will grow 17% in 2011 to $76 billion. The fastest growth -- between 1.3 and 1.5 times the industry average will come from financial services -- including banking, financial services and insurance with demand in the U.S. account for the most revenue growth.

Cognizant's performance over the last five years has been great but its first quarter 2011 results disappointed analysts who seemed to be stretching for bad news. After all, Cognizant's Q1 2011 profit of $208.3 million was 38% more than the year before's $151.5 million while revenue grew 43% to $1.37 billion Not only that, but its operating margin widened to 19.4% from 19.1% despite a 52% spike in overhead costs.

Perhaps the problem was that its second quarter forecasts were slightly less than analyst expectations. Cognizant projected EPS of $0.65 cents in the second quarter, a penny below what analysts expected. But its revenue forecast of "at least $1.45 billion" exceeded analysts' $1.44 billion expectation.

But the worst news -- driving its stock down nearly 8% when it announced in early May -- was that some of its financial services business' major merger and acquisition projects in the U.K. are ending. Perhaps analysts were worried that it would be more difficult for Cognizant to beat expectations. Or more likely traders were using the glimmer of negative news -- which should not have come as a surprise -- to take profits.

So should you go add Cognizant to your portfolio? 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.

It's a fairly expensive stock -- trading at a PEG of 1.45. Cognizant's P/E is 29.5 and its earnings are forecast to grow 20.4% to $3.32 in 2012. But it also has a track record of beating expectations -- by an average of 5.2% in the last five quarters.

This company is a very strong player in an attractive industry. I would look at buying it at a lower entry point in the event of a market break. While currently pricey, Cognizant could be a good long-term holding.

Thursday, May 26, 2011

Is Going Long Microsoft Another Bad Ira Sohn Conference Idea?

David Einhorn, President of hedge fund Greenlight Capital, owns almost 9.1 million shares of Microsoft (MSFT). On Wednesday, he gave a speech at the Ira Sohn Investment Conference where hedge funds give out investment ideas to raise money for charity. Can you profit from Einhorn's tip on Microsoft?

The Ira Sohn has been a source of interesting ideas that have not always panned out. In 2010, another hedge fund honcho, Steve Eisman, recommended that investors bet on a decline in stocks in the for-profit education industry. As I posted in June 2010, the case he made regarding the shoddy business practices in the industry was compelling.

Eisman's key allegation was that for-profit education companies used aggressive tactics to enroll people in programs they could not afford while borrowing money from a government program. The for-profit education companies, however, did not suffer when the newly enrolled students -- most of whom did not pay back their loans -- defaulted.

Eisman believed that the Department of Education was going to crack down on these business practices and make it much harder to get those government loans. While stocks of companies in the industry did decline, they are pretty much back to where they were a year ago -- based on the reality that things did not turn out as badly as Eisman had thought. For example Bridgepoint Education (BPI) fell from $23 in May 2010 to about $13 in August and now stands at about $23.

This suggests that Eisman mis-calculated -- shockingly enough, Bridgepoint stock rose 15% on Wednesday after it was named the best investment idea at the Ira Sohn conference Wednesday. A year ago Bridgepoint was touted as a short -- yesterday, as a long. I guess some people have short memories.

So you should take with a grain of salt Einhorn's comments on Microsoft (although his 9.1 million shares show that he is putting some money where his mouth is). On Microsoft, he made funny comments that its CEO, Steve Ballmer, is like Charlie Brown, a perpetual loser.

But that's not really news. As I posted in June 2006, when Bill Gates retired as CEO, the stock had been dead money for the preceding five years -- falling from about $57 at the end of 1999 to $22. Since then its stock has stayed dead -- having risen to an unimpressive $24 -- a five year annual growth rate of 1.75%.

In the past five years under Ballmer the market has lost interest in the stock -- even though some measures of its financial performance have improved. For example, its return on equity has risen from 25.5% to 40.6% from 2006 to 2010 while its net margin declined just slightly from 30.8% to 30%. Meanwhile, Microsoft's Price/Earnings ratio tumbled from about 22 to 13 (it was 46 10 years ago).

My interpretation is that Microsoft sales growth is too slow to interest investors. In the last five years, Microsoft sales have risen at a 9.5% annual rate -- far below the applications software industry growth of 14.1%. And that industry average is way below the far more interesting comparable growth rate for Apple (AAPL) -- 36.2% that has contributed to Apple's 41.2% 10-year average annual stock price appreciation.

Microsoft generates plenty of cash thanks to its dominance of PC operating systems and office applications. Alas, the world is moving away from PCs and onto wireless devices and social networks. And as Einhorn told the Sohn conference, Ballmer's “allowed competitors to beat Microsoft in huge areas, including search, mobile-communications software [its market share there has tumbled from 6.8% to 3.6% in the last year], tablet computing and social networking. Even worse, his response to these failures has been to pour tremendous resources into efforts to develop his way out of these holes.”

Yet Microsoft's recent profit performance has not been all that bad. In its third quarter ending April, revenue was up 13% to $16.43 billion -- 1.4% above estimates -- while operating income climbed 10% to $5.71 billion as net income spiked 31% to $5.2 billion. And its earnings per share of $0.61 were five cents ahead of estimates.

This overall performance masked variations among the divisions. Microsoft's online service lost money and its Windows unit suffered a 7% sales decline on weak PC demand. But its gaming division enjoyed a 60% revenue pop on the sale of 2.4 million Kinect game controllers. Its office software division enjoyed a 21% sales increase; and its server and tools division saw an 11% sales boost.

To Ballmer's credit, the gaming division is one area where Microsoft's investment in new businesses has paid off. I'd advise Microsoft's board to spin that off because the rest of Microsoft's moribund businesses are masking its exciting growth prospects.

But for the time being, investors don't have that choice. So should you go with Einhorn on Microsoft? 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.

Microsoft trades at a low PEG of 1.35. Its P/E is 9.6 on earnings forecast to grow 7.1% to $1.76 in 2012. This stock is not over-valued but at that PEG ratio, it does not offer anything to get excited about -- unless a 2.65% dividend yield makes your day.

If Microsoft's board could spin off its gaming division and put Ballmer in charge -- then let Steve Jobs run the rest of Microsoft, this stock would look exciting. But that will never happen so for all the media attention that Einhorn's Ira Sohn plug received, Microsoft is likely to remain dead money.

Wednesday, May 25, 2011

Is Ralph Lauren's Drop A Buying Opportunity?

Shares of Ralph Lauren (NYSE: RL) are down 6% in Wednesday morning trading after the upscale clothing retailer announced a 36% drop in earnings. Does the stock price drop make Ralph Lauren's shares a bargain?

Ralph Lauren fell short of analysts' earnings estimates. It fourth quarter net income fell to $73.2 million, or 74 cents a share -- five cents short of analysts surveyed by Bloomberg. Revenue was up 6.7% to $1.43 billion from a year earlier, when Ralph Lauren reported net income of $114.1 million, or $1.13 a share.

The cause of the earnings miss is higher cotton prices and higher pay for Asian workers that Ralph Lauren did not pass on in the form of higher prices to consumers. As a result, Ralph Lauren's gross margin was down 2.2 percentage points to 56.8%  -- 0.7 percentage points less than, Michael Binetti, a UBS Securities analyst had expected.

Is Binetti right that Ralph Lauren's shares are a buy? 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.

Ralph Lauren's PEG of 1.52 makes it a little pricey. It trades at a P/E of 19.6 on earnings expected to grow 12.9% to $6.53 in 2012. If Ralph Lauren continues to suffer lower operating margins in the 1 percentage point to 1.5 percentage point range in the next year, its stock is likely to be under pressure.

But Ralph Lauren's brand strength is such that I would keep an eye on the stock's P/E relative to earnings to look for a cheaper entry point.

Should You Bet on Yandex?

2011's biggest initial public offering (IPO),Yandex (NASDAQ: YNDX) -- Russia's version of Google (NASDAQ: GOOG) -- went off without a hitch Tuesday -- but did not receive as much media attention as LinkedIn's (NASDAQ: LNKD) IPO.

Yandex -- the name stands for Yet Another Indexer -- dominates the Russian market for search. Tapping Russia's math and engineering talent, LiveInternet reports that Yandex's search engine is so successful that it now controls 64% of the Russian market nearly triple Google's 23%. Yandex started in 1997 and beat Google to market -- it entered Russia in 2005 -- with maps, news search, and Web mail.

And the Internet advertising market from which Yandex derives 97% of its revenues is large and growing fast. Globally, Internet advertising will contribute to 37% of 2011's global advertising growth according to Group M -- and will take over newspaper spending in 2012. And the Russian online advertising market is expected to grow even faster than the global market -- at 27% annual rate between 2011 and 2015 as Russian Internet penetration climbs from 30% to 70% according to Russia’s Public Opinion Foundation.

Yandex's financial performance has been solid. Its 2010 revenues were $440 million and it earned a profit of $134 million or 44 cents a share. Based on its closing price of $38.84, up 55.4% on its first day of trading, Yandex's Price/Earnings ratio is a steep 88 (although that pales in comparison to LinkedIn's P/E of 584 after its first day of trading.)

Before getting into whether Yandex's stock price could rise further, it's worth pointing out that the company faces risks due to Russia's attitude towards corporate governance. For example, FT.com reported that Yandex coughed up personal information to Russia’s security service of Yandex Money users who made electronic contributions to a Russian anti-corruption organization.

If that kind of thing doesn't both you, the next question to consider is whether a P/E of 88 can be justified by Yandex's future growth rate. Between 2006 and 2010, Yandex's net income grew at a 36% annual rate. If you think it can more than double this growth rate, then a P/E of 88 might be justified, otherwise the implied Price/Earnings to Growth Ratio of 2.67 (where 1.0 looks fairly valued) appears pretty expensive to me.

I would keep your eye on this equity because it is the dominant player in a fast and rapidly-growing market. But I would wait to buy the shares after seeing whether it can grow into its lofty valuation. 

Tuesday, May 24, 2011

Does Vertex Pharmaceuticals Belong in Your Portfolio?

When it comes to biotechnology, it is important to be losing huge amounts of money. Without those losses, how can the company make passionate claims about how much better it will do in the future? This is the basic philosophy behind selling shares of unprofitable research projects to the general public.

And it may help explain why Vertex Pharmaceuticals (NASDAQ: VRTX) -- in the news for getting its Hepatitis C drug approved and building a big new corporate headquarters on the Boston waterfront -- sports a market capitalization of $11.5 billion to go with its spectacularly bad -239% net profit margin. Is now the time to add Vertex to your portfolio?

Vertex is one of many biotechnology companies that have managed to sell shares to the public without generating a penny of profit. Drugs take a long time to go from a research lab into people's bloodstreams and getting them there involves big risks and big money. Vertex's corner of this world includes "phase-I clinical trials and/or nonclinical activities for treatments of hepatitis C virus infection, cystic fibrosis and influenza."

Reaching that potential spells ugly financial statements in the case of Vertex. Between 2007 and 2010, Vertex lost an impressive $2.2 billion on revenues of $620 million. Of its $2.8 billion in operating expenses, 79% went to research and development and most of the rest to selling, general and administrative expense.  To keep this research machine going, Vertex has persuaded equity and debt investors to part with about $2 billion worth of their hard-earned cash. 

Good news for long-suffering Vertex shareholders came on Monday when the Food and Drug Administration approved its hepatitis C drug, Incivik. 170 million people have hepatitis C -- 3.2 million of them in the United States. Incivik is expected to gain 70% of the market for hepatitis C treatments due to its superior cure rate of 79% compared to the 66% rate of Merck's (NYSE: MRK) Victrelis.

FDA approval of Vertex's Incivik is expected to change Vertex's financial profile for the better. How so? At $49,200 for a 12-week regimen, Incivik could generate $5 billion in sales -- $1 billion more than the $4 billion cost of developing it, according to Vertex CEO, Matthew Emmens, who expects Vertex to become profitable in 2012. If you take into account the cost of making and selling Incivik, it might break even on that investment.

In what can be seen as an amazing coincidence, this good news on the FDA front is accompanied by other news on Vertex's real estate front. On Monday, the company announced that it is constructing two buildings totaling 1.1 million square feet for $800 million on Boston's Fan Pier. Vertex plans to move its 1,500 employees there when the project is completed in 2013 or 2014, according to the Boston Globe.

Meanwhile, Vertex's stock market value has soared. Since its 1991 initial public offering, Vertex stock has risen 11 fold to its current $55.81. Its best year was 2000, during which the stock spiked from $18 in January to $94 in November. It then plummeted and spent the following decade below its peak. However it's enjoyed a revival in the last 12 months -- rising 64%.

What does the future hold for Vertex? If Goldman Sachs's (NYSE: GS) April 2011 call is to be believed, Vertex's stock price should hit $59 -- so all so all but 5.7% of the upside for the company is currently reflected in its stock price. Perhaps more interesting is that Goldman believes that Vertex will earn a profit between 2012 and 2015. In April, Goldman raised its EPS estimates for Vertex by 5% to $5.36 in 2012, $7.13 in 2013, $6.41 in 2014 and $6.25 in 2015.

That four year average growth rate in earnings of 3.9% is not all that exciting. Although investors will no doubt focus next on the prospects for Vertex's other research projects. One thing's for sure -- Vertex's decision to build an edifice on the Boston harbor after decades of losing money suggests that it has tremendous confidence in its ability to convince investors to part with their money.

But so far, it has not demonstrated that it can use that money to generate enough profit to offset that investment. What's broken in our financial markets is that the hope that Vertex might someday offer such a return is enough to drive up its stock price.

In my humble opinion, that is a pretty thin reed on which to bet a part of your portfolio.

Monday, May 23, 2011

What's the Book on Barnes & Noble?

Barnes & Noble (NYSE: BKS) popped 30% on Friday thanks to a takeover offer from Liberty Media (NYSE: LCAPA). Does this offer signal that it's time for investors to buy the stock?

Barnes & Noble (B&N) operates bookstores and it sells a so-called eBook reader. At the end of January 2011, B&N ran 705 bookstores, operated 636 college bookstores, and sold the NOOK eBook reader, in a business segment that also operates its web site.

B&N is in surprisingly good financial shape considering that the industry is so difficult that competitor, Borders, recently filed for bankruptcy. In the quarter ending January 2011, B&N comparable store sales increased 7.3% -- beating its 5% to 7% forecast. And its consolidated third quarter earnings were $60.6 million -- at $1.00 per share, this result was consistent with its guidance of $0.90 to $1.20.

The bad news for investors was that B&N used the Borders bankruptcy as an excuse to stop issuing guidance for sales and earnings. (Of course it's possible that taking out a competitor could help B&N gain sales). B&N also suspended its dividend -- that had cost B&N $45 million in the quarter ending in January. And when you consider that the company ran through $35 million of cash in the previous nine months and had a mere $26 million left, the decision to suspend the dividend signals a pretty serious cash flow problem.

So perhaps the May 20th offer from Liberty Media to acquire B&N -- after putting itself up for sale in August 2010 -- is well-timed. Liberty Media offered $500 million for a 70% stake in Barnes & Noble contingent on its current CEO, Leonard Riggio, staying on and holding on to his 30% stake. As Liberty Media CEO, John Malone, told the Financial Times, “I am also firmly of the view that there will be an enduring demand for physical bookshops, which are cultural centres within local communities.”

Most analysts consider Malone's offer as an opportunity to gain control of the NOOK. As James McQuivey, an analyst at Forrester Research, told Variety, "It's absolutely a play for the Nook. The real value of B&N right now is the ascent of its Nook platform, which is turning out to be a very solid foundation for building a digital media relationship with millions of consumers. And the fact that the Nook Color is being snatched up as quickly as B&N can make it is good evidence that the business has strong prospects in new directions like web apps and even video."

It's hard to know how much the NOOK is contributing to sales and profits since its sales are buried in reporting for its online unit. But that part of the company enjoyed a 52% spike in sales in the most recent quarter -- to $319.4 million. However, it represents a mere 13.7% of its revenues and lost $57 million during the period.

This leaves open the question of what will happen next. If the Liberty Media deal falls through, B&N stock will drop 30% back to where it was on May 19. If the Liberty Media deal closes, the stock will stay where it is for the time being -- but if Malone is correct that he's making a value buy, it could go up, say, another 30%.

How is an investor to decide what to do here? For that, I suggest taking a look at the concept of expected value (EV). EV theory says that you should consider the probability of a range of outcomes and multiply the probability of each by its payout and add up the EVs for each possible outcome. If the EV is positive, then you should invest, otherwise you should stay away.

The hard part of applying EV is that doing so involves making many assumptions -- all of which could be wrong. But for the sake of illustration, let's make the following assumptions (these figures are on a price per share basis):
  • EV of Deal Falling Through: ($0.84). This assumes that there is a 20% chance the deal will fall through meaning the stock falls $4.22 a share, to where it closed on May 19. 
  • EV of Higher Offer: $0.73. A 20% chance of a new offer coming in that values B&N at $22, a 20% premium over its current price. SeekingAlpha thinks it's possible that Microsoft (NASDAQ: MSFT), Google (NASDAQ: GOOG), SearsHoldings (NYSE SHLD), or Amazon (NASDAQ: AMZN) could put in a bid.
  • EV of Deal Going Through: $0. A 60% chance of Malone's deal going through -- which would leave the stock price unchanged.
Based on these assumptions, you should not invest in B&N stock because its EV/share is negative 11 cents. But if Malone makes the deal and B&N's value increases 30%, then the expected value of the investment would be positive. The only problem with that for a buyer of the stock today is that the benefit of that increased value would only go to Liberty Media and Riggio.

Avoid this stock.

Friday, May 20, 2011

Can Tesla Motor Your Portfolio Higher?

LinkedIn (NASDAQ: LNKD) had a boffo IPO Thursday that values its shares at a fairly high P/E of 584 -- about 37 times that of the average stock. But that's nothing compared to Tesla Motors (NASDAQ: TSLA) that sports a $2.7 billion market capitalization -- up 18% from its July 2010 IPO price -- despite losing $154 million on $117 million in sales in 2010. Should you hold your nose and buy?

Tesla Motors makes cool-looking electric cars. Its Tesla Roadster than can go 236 miles on a single charge. As of March 2011, Tesla had sold 1,650 Roadsters -- starting price $109,000 -- in 30 countries and it currently has 17 dealers. It also sells battery packs to Daimler -- "up to 1,000 battery packs and chargers to support a trial of the Smart for two electric," according to its most recent 10Q.  And it has received "more than 4,600 reservations" for another vehicle, the Model S.

Tesla's financial results are not as cool. For example, in the first quarter of 2011, Tesla reported a $48.9 million loss, or 51 cents a share -- that was 66% bigger than its $29.5 million loss in the previous year of $4.04 a share (its common share count rose 12-fold from 7.3 million to 95.2 million over the period).

But the good news is that Tesla's sales rose 136% to $49 million from $20.8 million and it beat by a penny analysts' forecast for an adjusted loss of 52 cents a share and by 14% revenue expectations of $43 million. If you are an investor in this stock, you are likely to seize on this good news as a reason to keep holding on.

Needless to say, a new car company has big cash needs. And it could not meet those needs without help -- it gets $465 million worth from the U.S. government in the form of a so-called loan facility from the Federal Financing Bank (FFB) that is guaranteed by the Department of Energy (DOE) Loan Facility.

This facility under the DOE’s Advanced Technology Vehicles Manufacturing Loan Program (ATVM Program) is helping to pay for Tesla to develop that Model S. And its business prospects could dim Tesla does not meet the development milestones required to get more of that cash.

Meanwhile, Tesla has about $101 million worth of cash on its balance sheet and is going to be required to come up with $17.5 million in 2011. Curiously, despite $102 million in long-term debt, Tesla does not record any interest expense on its income statement for the first quarter. Its 10Q suggests that Tesla is "capitalizing the interest expense to construction in process" -- meaning it is adding the expense to the value of the asset rather than actually paying it.

Is this just a tiny, obscure accounting matter or cause for investor concern?  You could just look on the bright side -- on May 4, Tesla Motors raised its guidance for 2011 sales by 6% from between $160 million and $175 million to between $170 million and $185 million.

But I wonder how long a company can survive making a bigger net loss than its total sales. Its market capitalization depends on its ability to convince investors to keep using their hearts and not their brains when it comes to deciding whether to fork over their hard-earned cash.

I'd avoid this equity.

Thursday, May 19, 2011

Gingrichonomics: Should Tiffany Trickle Down to Your Portfolio?

Tiffany (NYSE: TIF) stock is on a tear. And with those at the top doing better than ever -- Notwithstanding 2012 Republican presidential candidate Newt Gingrich's up to $500,000 in unpaid Tiffany bills  -- there is an opportunity for the bottom 99% to get some of that trickle down effect. Can you profit by stocking up on Tiffany shares?

As gasoline prices have risen by $1.30 a gallon over the last year, the split between the top earners and the rest of America is becoming more pronounced. And when the prices of other items rise later in 2011 -- clothing will spike 10% to 15%, meat prices will rise 6% to 7%, and the USDA estimates that dairy product prices will increase 5.5% -- that gap will widen further. 

How so? Citi Investment Research reports that for those in the bottom 20% who make a median income of $9,846, 35.6% of their income goes to buy food and 9.4% to gasoline. Whereas for the top 20% whose median income is $157,631, only 6.8% goes for food and 1.9% for gasoline -- this leaves the other 91.3% for spending on other things.

And based on the $3 billion (2010 sales) Tiffany's most recent comment on its first quarter earnings report -- expected to be delivered next week -- it looks like some of that money is going for jewelry. On March 21, Tiffany reported that it expected 2011 sales to be up between 12% and 14%.

But there's one problem -- 24% of its 233 stores around the world are in Japan -- and Tiffany expects a "mid-single-digit percent decline" in those stores. As a result, Tiffany reduced its first quarter earnings per share estimate from 62 to 57 -- still two cents above analysts' estimates.

Still, Tiffany stock has been going gangbusters -- sitting near an all time high of $70.13 and yielding a market capitalization of $8.94 billion. And those shares have risen more than 37 fold since their initial public offering price of split-adjusted $1.82 on May 15, 1987 at a compound annual growth rate of 16.4%.

Tiffany stock is a barometer of the growing wealth at the very top of the economic pyramid. And with corporate profit having hit a record $1.68 trillion in 2010 while unit labor costs fell 1.5% and productivity rose 3.9%, executives enjoyed a 24% pay raise in 2010 -- even as workers are squeezed between lower wages and higher food, energy, and clothing costs.
   
But if those workers have any spare change, could investing in Tiffany give them a share of the trickle down effect? 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.

At a PEG of 1.60 Tiffany is a pretty expensive stock. Its P/E of 24 compares to earnings expected to grow 15% to $3.82 in 2012. So the biggest chance for an increase in Tiffany stock price would be the result of a positive earnings surprise.

But a look at its most recent five quarters' earnings surprises yields mixed news. On the one hand, Tiffany has exceeded analysts' estimates by an average of 13% over the most recent five quarters. On the other hand, this average masks wide variations by quarter -- in some, Tiffany was 4% over estimates and in others it out-performed by as much as 33%.

If the past is a prologue, then Tiffany could deliver a meaningful upside surprise when it reports first quarter results. Given its high valuation, any disappointment could be bad for the stock. If you think Tiffany will beat by a wide margin, this might be a good time to buy. Otherwise, consider it again after Tiffany plummets should its earnings disappoint investors.

Wednesday, May 18, 2011

As Corporate PC Demand Rises, Dell's Up, HP's Down

Two powerful trends are shaping the opportunity to profit from investing in tech stocks. The first is a change in the mix of technology spending from consumers to companies. And the second is the popularity of Apple's iPad -- 20 million have been sold since its April 2010 introduction. Neither trend is likely to reverse soon. And that means investors might consider buying Dell (NASDAQ: DELL) and staying away from Hewlett-Packard (NYSE: HPQ).

Over the last two decades, the lead in source of technology spending has changed hands a few times. During the 1990s, there was a boom in corporate technology spending as companies upgraded their computing infrastructures to compete in e-business.

Companies bought PCs online largely from Dell. As I wrote last June, Dell set up its business in a way that enabled it to set its costs 14% below those of competitors like Compaq (that HP bought in 2002) while charging companies a 13% higher price because of the convenience its online purchasing process gave companies who could order PCs configured for their specific requirements.

During the 2000s, companies lost interest in IT as a source of competitive differentiation and focused on trying to make it more efficient by shifting basic functions to lower cost countries. PC growth came from consumers -- who like to buy PCs after checking them out in retail stores -- where HP excelled and Dell did not. Dell's strength selling to companies became a weakness when it came to consumers -- and Dell's market capitalization fell $68 billion as a result.

Last year, Apple introduced the iPad and to my surprise, it has become a huge hit -- at least a decade after Microsoft (NASDAQ: MSFT) then-CEO, Bill Gates, walked around talking about the benefits of tablet computing. In the current decade, we are seeing the iPad cut into sales of PCs for consumers and that's hurting HP the most. Overall that PC market is shrinking at a 3.2% globally and 10.7% in the U.S.

Meanwhile, after a year of record corporate profits of $1.68 trillion and nearly $2 trillion in balance sheet cash, companies are finally beginning to spend more on technology after holding off for much of the previous decade. For example, in the first quarter of 2011, U.S. GDP growth was a slim 1.8% but that weak performance masked a much higher 11.6% spike in corporate technology spending -- a boom to Dell.

These trends help explain why HP's first quarter results were disappointing and why Dell delivered. At HP, consumer PC sales tumbled 23% in the first quarter and HP reduced its sales forecast by $1 billion. Meanwhile Dell beat analysts’ estimates because of corporate demand -- where it has traditionally done well -- while its sales to consumers fell 7.5%. Meanwhile tablet sales, the iPad and others, are expected to climb at a 52% compound annual rate from 70 million in 2011 to 246 million in 2014.

Does this mean you should dump HP shares and buy Dell? To think about that, To help with that decision, 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.

Based on PEG alone, I'd buy HP and sell Dell. How so? HP's PEG of 1.06 looks reasonable -- its P/E is 9 on earnings expected to grow 8.5% to $5.69 in 2012. Meanwhile Dell's PEG of 2.45 looks over-priced -- its P/E is 11.8 on earnings expected to grow 4.8% to $1.76 in 2012.

I may be going out on a limb here but based on Dell's 83% earnings growth in the first quarter to 55 cents a share (beating estimates by 10 cents), I think the 4.8% 2012 growth forecast could be way too low. And with HP earnings up a mere 5% in the quarter, the 8.5% 2012 forecast might be too high.

Tablet growth is going to be strong in the years ahead but it remains to be seen how strong it will be in the corporate market. Nevertheless, it would not hurt if Dell could offer a compelling corporate tablet -- its Streak currently controls a tiny 3% of the market -- in a decade during which companies are likely to boost their IT spending dramatically, Dell's stock should benefit.

Tuesday, May 17, 2011

Why You Should Bet With Buffett on MasterCard

Warren Buffett's Berkshire Hathaway (NYSE: BRK.A) placed a big new bet on MasterCard (NYSE: MA) in the first quarter. Should you follow him into the stock?

Buffett's stake was disclosed in a 13F filing totaled 216,000 MasterCard shares valued at $60 million -- a tiny portion of its $53.6 billion equity portfolio. On the face of it, a stake in MasterCard could be a bet by newly hired investment manager, Todd Combs, on an increase in consumer spending.

But let's look deeper at MasterCard. The Purchase, NY-based company supports provides credit, debit, and prepaid programs for 22,000 financial institutions. And MasterCard's economic performance of over the last five years has been impressive. After all with $5.73 billion in sales growing at an average of 13.5% a year since 2006 and net income of $1.95 billion spiking at a 47.2% average annual rate over that time frame, MasterCard is a profit growing machine with an impressive 34% net profit margin.

But what has MasterCard done for investors lately?  In the first quarter of 2011, the number of transactions climbed 11% and volume growth rose13% while client losses fell further. Revenue grew 15% to $1.5 billion with operating margin of 55.7% up 2.2 percentage points. MasterCard's EPS of $4.29 increased 24% and beat Lazard Capital Markets' forecast of $4.10. And MasterCard boosted its EPS estimates for 2011 to $17.15, up 14%, and to $20.16 for 2012, up 1%.

Does this performance mean that you should add MasterCard stock in your portfolio? To help with that decision, we can look at its Price/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.

MasterCard's PEG of 1.07 is a reasonable value. Its P/E is 18.8 and MasterCard's earnings are expected to grow 17.5% in 2012 to $19.99. With Buffett's backing and the real chance that it can sustain a higher earnings growth rate based on its performance over the last five years, buying MasterCard stock could be a profitable addition to your portfolio.

Has PepsiCo Peaked?

PepsiCo (NYSE: PEP) recently hit a new 52-week high and currently sports a $112 billion market capitalization. And with CEO Indra Nooyi pushing Pepsi to develop healthier snacks and drinks that still taste great, is PepsiCo stock poised to pop or has it peaked?

On May 12, the stock of PepsiCo, the $60 billion (most recent 12 months' sales) drink and snack powerhouse headquartered on an old polo ground in Purchase, NY, hit $71.27, culminating the most recent two months, during which its shares spiked 16% after a fairly dull year of 4.7% price appreciation.

Investors may have been pleasantly surprised by its first quarter 2011 earnings. Although PepsiCo's net income fell 20% to $1.14 billion compared to the previous year, its adjusted Earnings Per Share of 74 beat analysts' estimates by a penny. And revenue rose 27% to $11.94 billion -- beating analysts' estimates by 2%.

Moreover, PepsiCo announced good news for the rest of 2011. It expects 7% or 8% EPS growth over 2010's $4.13, despite commodity cost inflation of between 7.8% and 8.9% on its $18 billion base of commodity-based input costs. The reason for the continued EPS optimism is that PepsiCo plans to boost prices during the peak soft drink selling season that begins after July 4.

Meanwhile, PepsiCo is investing in new products that it believes will encourage more people to buy more of its products to fulfill Nooyi's adage, Performance with Purpose. According to the New Yorker, PepsiCo is developing products that contain less salt and sugar while preserving the taste experience that makes consumers keep coming back for more. It is also developing so-called functional foods -- such as different versions of Gatorade for the periods before, during, and after you exercise.

Do such products mean that you should pop PepsiCo's stock in your portfolio? To help with that decision, we can look at its Price/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.

PepsiCo's PEG of 2.11 makes it pretty expensive. Its P/E is 19 and PepsiCo's earnings are expected to grow 9% in 2012 to $4.90. PepsiCo stock yields 2.91% but at its current price, unless it can accelerate its earnings growth with those new products Nooyi is pushing, Pepsi stock may well have peaked.

Monday, May 16, 2011

Should You Short OpenTable?

OpenTable (NASDAQ: OPEN) is attracting short sellers like rotten meat attracts flies. Should you join them?

OpenTable lets people make restaurant reservations online and charges the restaurants a one-time installation fee for on site installation and training, a monthly subscription fee for the use of its software and hardware and a fee for each restaurant guest seated through online reservations. In March 2011, 20,000 restaurants used its services as did 7.5 million diners a month.

OpenTable has put in a great performance since going public two years ago. From its May 2009 IPO price of $28.48 a share it rose as high as $116 in April 2011 before tumbling to its current $93. In the past 12 months, it generated $111 million in revenue up 44% and $15.6 million in net income, a 184% spike.

But some investors think that OpenTable is over-valued. To bet that a stock will drop, investors can sell its shares short. To do that, they borrow the shares from a broker who sells them at the market price and puts the proceeds of the sale into an escrow account. If the shares later drop below the price that you sold them, investors can go out into the market and buy back the borrowed shares at a lower price, repay the share loan, and pocket the difference between the original price and the price at which they bought back the shares.

If the price of the stock goes up after the broker sells the shares, investors must put up more cash fast to cover their losses or take their losses immediately by buying the shares in the open market immediately and repaying the broker. It is what happens if a short bet goes bad that makes it very important for an investor to be right before taking the risk.

The level of short interest in OpenTable has more than tripled since April 2010. Back then 1.7 million shares of the company had been sold short, representing 14.9% of the then average daily volume. Since then, OpenTable's short interest has risen to 5.03 million at the end of April 2011, a short-interest ratio of 3.9%. But as of mid-April 2011, OpenTable's short interest was 5.7 million -- suggesting that some investors are getting nervous about this trade or have taken all the profits that they need.

Why have investors expected the stock to drop? Its Price/Earnings ratio of 145 is about nine times higher than the market average P/E. And in my observations of the market, if a company with a high P/E does not beat analysts' earnings expectations and raise its guidance each quarter, investors will decimate its stock price.

But OpenTable is not giving much to investors hoping to profit from its decline. In the first quarter of 2011, OpenTable reported adjusted earnings of $0.28 a share, five cents above estimates. Net income rose 68% to $4.2 million. And revenue leaped 59% to $33.7 million just beating analysts' $33.6 million forecast.  

Of course there was just one little problem -- OpenTable replaced its CEO with its CFO. Investors cut the stock back 7.6% on the news. Perhaps there was some concern about the growth of expenses at OpenTable. For example, its operating expenses spiked 56% to $27.2 million -- primarily due to a 50% increase in its headcount following its toptable.com acquisition.

I would advise selling short a stock that has a better than 50% chance of going bankrupt. Otherwise, investors are taking the risk that their bet on a price drop is right in the long run but wrong in the next three months. And given the market's requirement that short sellers cover their bad bets by buying shares, a short bet combined with better than expected earnings can cause the price to rise really fast due to a so-called short squeeze in which panic buying forces more short sellers to buy.

Since OpenTable's earnings are expected to rise 68% to $1.57 in 2012, its Price/Earnings to Growth (PEG) ratio is a very expensive 2.13. On the other hand, OpenTable has no long-term debt so it is in no danger of going bankrupt and its cash rose 30% in the first quarter from the previous three months.

OpenTable is an expensive stock but the risks of selling its stock short outweigh the upside.

Wednesday, May 11, 2011

With CEO Out, Is Boston Scientific A Takeover Target?

Medical devices maker, Boston Scientific (NYSE: BSX), just announced that its CEO was leaving and its stock plunged 9%. This departure raises a question about whether this troubled company could be a takeover target. Should you invest?

Ray Elliot joined Boston Scientific, the second largest maker of implanted heart devices, such as stents and defibrillators, as CEO in July 2009 and he announced Tuesday that he was leaving at the end of 2011. Elliot had been known as "an industry tough guy" when he joined the company from orthopedics device maker Zimmer Holdings (NYSE: ZMH), according to Bloomberg.

But Elliot's bluster exceeded his performance. Under his tenure, sales fell -- 4.7% in 2010 to $7.8 billion and quarterly sales fell below the $2.1 billion level they reached the quarter before Elliot started there. In the most recent quarter, revenue declined 1.8% to $1.9 billion and Elliot was expecting a "difficult" 2011.

The sad thing is that Boston Scientific used to be a high flyer. It was one of the top performing stocks in my investment newsletter back in 2004. Between 2000 and 2004, its stock rose straight up from $6 to $45 as its Taxus dominated the market for drug-coated stents. But things went downhill and in 2006, Boston Scientific made what turned out to be a disastrous $27.3 billion acquisition of medical device maker, Guidant -- in a pyrrhic takeover battle victory over its stent rival, Johnson & Johnson (NYSE: JNJ).

What went wrong with this deal is an object lesson in what not to do in an acquisition. Boston Scientific overpaid, took on nearly $9 billion in debt, and in the process ignored technical problems with Guidant's defibrillators that led to costly lawsuits -- 4,000 of which were settled for $195 million. From its peak at $45, Boston Scientific stock is down 84%.

Is Boston Scientific stock a bargain at this price? At a P/E of 18.5, the company is expected to make $0.45 a share in 2012, up 15% from the $0.39 it's forecast to earn in 2011. If that 2012 forecast is accurate, the stock trades at a Price/Earnings to Growth (PEG) of 1.23, not overly expensive.

Unfortunately, Boston Scientific's short-term prospects are not as good. Its 2011 earnings are expected to be down 18% and the company is likely to suffer a talent exodus as its board spends the next few months trying to convince a new CEO to step in.

Meanwhile, Boston Scientific faces cash flow concerns. In 2011, the company is on the hook to repay $500 million in debt and in 2010, its cash balance plunged 75% to $213 million. How will it come up with the half a billion dollars? And in December 2010, the IRS charged Boston Scientific with underpayment of taxes to the tune of $525 million plus interest, according to its 2010 10K.

With all its problems, Boston Scientific is hardly the ideal takeover candidate. Yet its strong market position would make it a tempting target for J&J or market leader, Medtronic (NYSE: MDT) -- particularly if all its liabilities could be used to take a big bite out of the purchase price.

For investors with strong tickers and an iron-coated stomach, taking a bite of Boston Scientific at its current level, could be a profitable bet.

Tuesday, May 10, 2011

Does Recent Oil Plunge Spell Opportunity to Invest in Chevron?

Stock in Chevron (NYSE: CVX), the second largest oil company, has taken it on the chin in the last few weeks -- falling 4.6% since the beginning of May. But Chevron is a very solid company and if the global economy keeps growing, it could be a great way to invest in that growth. Should you add it to your portfolio?

Chevron has operations around the world in petroleum, chemicals, mining, power generation and energy services. It explores for, develops and produces crude oil and natural gas; transports crude oil by international oil export pipelines; transports, stores and markets natural gas, and a runs a gas-to-liquids project. Chevron's so-called downstream operations refine crude oil into petroleum products and they market crude oil and refined products.

And Chevron has put in a solid financial performance. Its $217 billion in sales over the last year have been growing -- very slowly at a 0.67% five year compound annual growth rate while its net income of $20.7 billion has risen at a more robust 6.7% over the last five years.

But Chevron has been lagging its peers. It is growing more slowly than the industry -- its sub-1% sales growth compares unfavorably to the industry average of 7.5% over the last five years. five year average net profit margin of 8.3% is lower than the industry average of 11.1%. But the good news is that its five year average return on equity of 21.9% edges out the industry's 20.2%

Chevron's more recent financial performance has been respectable. Last month, it reported $6.21 billion in first quarter 2011 profit, or $3.09 a share up 36%, compared to $4.55 billion, or $2.27 a share, a year earlier. Its revenue climbed 25% to $60.34 billion and it beat analysts' estimates of $3 per share "mainly due to better-than-expected performance in its international exploration-and-production segment and higher oil price realizations," according to Dow Jones Newswires.

Should you buy on the recent dip? To make that decision, you might consider using the price-to-earnings-to-growth (PEG) ratio that compares a stock’s market valuation to its forecasted earnings growth. By that measure, if a stock trades at a PEG of 1.0 or lower, it is reasonably priced. Higher than that, and it looks overvalued.

Chevron's PEG of 3.45 -- based on a P/E of 10 on earnings expected to grow 2.9% to $13.14 in 2012 -- looks expensive to me. Of course, if the price of oil plummets, that bet will look even worse. That's because the more a trader has to set aside to control oil futures contracts, the less attractive that trade will look due to the higher risk.

So keep your eye on how much margin those oil traders are required to keep in their accounts -- if that figure rises far above the current $8,438, the price of oil could drop further. In the meantime, if you think Chevron can keep growing earnings at 36%, then its PEG is a mere 0.28. But if you think that growth will slow down to the 2.9% that analysts forecast, beware.

Should You Park Your Cash in LinkedIn's IPO?

It has been a long time since a wave of venture-backed information technology initial public offering (IPOs) from the U.S. went out to investors. Sure there have been IPOs of plenty of Chinese startups and leveraged buyout firms have been selling themselves and their debt-laden properties to the public in recent years. But wireless network provider, Boingo Wireless (NASDAQ: WIFI) went public last week. And LinkedIn (prospective listing NYSE: LNKD), a business networking site, may soon help kick off a new wave of venture-backed IT startups to go public. Should you invest?

In considering such decisions, it helps to have a framework. And this one is adapted from my 2001 book, e-Stocks. I'd suggest looking at LinkedIn from four perspectives:
  • Industry. Is the industry in which the company competes large, rapidly growing and profitable?
  • Competitive Position. Does the company have a dominant position in the industry?
  • Management Team. Is the company's management team likely to be able to lead the company effectively in the future?
  • Valuation. Does the price leave room for upside growth?
The professional networking industry is large -- although it's difficult to put a precise number on just how large. LinkedIn's prospectus claims that the company has "more than 100 million members in over 200 countries and territories."

And its rapid growth attests to the growth opportunities in the industry and to LinkedIn's competitive advantage. Between 2003 and 2011, its membership count has grown at a 145% compound annual growth rate from 78,000 members to over 100 million. In the process, LinkedIn has found ways to monetize that growth by offering marketing solutions in September 2004, hiring solutions in March 2005, premium subscriptions in August 2005, and Corporate Solutions (a hiring service), in March 2008.

LinkedIn has succeeded in attracting a sizable customer base. In 2010, 3,900 companies used its  hiring solutions were used by nearly 3,900 companies and by the end of March 2011, that figure had grown to "nearly 4,800 companies, including 73 of the Fortune 100." In 2010, 33,000 small and medium-sized businesses used its marketing solutions.

LinkedIn's management team has impressive depth. Reid Hoffman, its chair, was an executive at PayPal and its CEO, Jeffrey Weiner, was an executive at Yahoo (NASDAQ: YHOO). Its other executives and board members reads like a who's who of 1990s Internet stars. Bringing LinkedIn to the stage of issuing public shares suggests that they were not content to rest on their previous laurels and that their prior public company success may help them manage LinkedIn.

The final question is whether the valuation is reasonable. If it sells shares at $35, it will be valuing itself at a P/E of 206 based on 2010 earnings per share of $0.17. That sounds really high -- given that the S&P 500's P/E is about 16. In LinkedIn's defense, its 2010 revenue grew 102% to $243.1 million while its $15.4 million in net income was 487% above 2009's level.

If LinkedIn could keep that momentum going, its Price/Earnings to Growth (PEG) ratio would be an attractive 0.42. But the company expects to lose money in 2011 as it invests for growth.

So while LinkedIn has a strong management team going after a big market with an effective competitive strategy, its high valuation and uncertain financial prospects make an investment in its stock a pretty risky bet.

Monday, May 09, 2011

Does AOL Have Turnaround?

It's been about a year and a half since AOL (NYSE: AOL) was spun off from Time Warner (NYSE: TWX) and put under the leadership of former Google (NASDAQ: GOOG) executive Tim Armstrong. AOL reported another plunge in revenues and profits in the first quarter of 2011, but Armstrong continues to wax optimistic. Should you invest in AOL?

AOL's first quarter results do not contain much reason for optimism. Its first-quarter profit of $4.7 million, or 4 cents a share, was down 87% from $34.7 million, or 32 cents a share the year before. And its revenues fell 17% to $551.4 million. But the good news was that AOL's display advertising was up 4% on a 24% decline in subscription revenue.

And AOL has lost considerable market value since it merged with Time Warner in a record $166 billion deal back in early 2001. The New York Times reports that the number of AOL subscribers has dropped 86% from 22 million back then to 3.6 million today. And it is continuing to lose subscribers at the rate of 19,000 a day. AOL's market capitalization is now 98.7% below its peak, at $2.15 billion.

The origins of this market share loss are a strategy launched in 2006 to try to acknowledge that few people needed to pay for dial-in access to the Internet given the wide access to broadband services and to try to make up the difference by selling advertising through proprietary content. As I wrote back in July 2006, the new strategy would require AOL to makeup about $2 billion in lost revenue through advertising

That content strategy has not been  a rousing success. Since 2006, AOL has lost 69% of its revenues from $7.8 billion in 2006 to $2.4 billion in 2010 while net income fell from $718 million to a $790 million loss during the period.

The reason this content strategy is not working is pretty simple. AOL's content is targeted at a different segment of the population than those who actually subscribe to AOL's Internet access service. More specifically, AOL subscribers lean right while the content leans left. This gap makes it hard to sell more advertising since the left-leaning content is not attracting enough new viewers to make up for the loss in AOL's subscriber base.

The strategy to reverse AOL's decline rests on Arianna Huffington who started the Huffington Post (HP) and now runs AOL's content. AOL paid $315 million for HP -- that generated $30 million in 2010 revenues and had 25 million unique visitors. And the Times estimates that HP will generate $60 million in revenues in 2011 and a modest profit.

Is Tim Armstrong right that AOL stock is poised to pop? To make that decision, you might consider using the price-to-earnings-to-growth (PEG) ratio that compares a stock’s market valuation to its forecasted earnings growth. By that measure, if a stock trades at a PEG of 1.0 or lower, it is reasonably priced. Higher than that, and it looks overvalued.

But it's hard to calculate a PEG for AOL because it lost $827 million on last 12-months' revenues of $2.3 billion so it has no earnings on which to calculate a P/E. Moreover, its earnings are forecast to decline 3% from $1.11 in 2011 to $1.08 in 2012.

With all the other bad news, a 4% increase in display advertising seems like a pretty thin reed on which to base a turnaround bet.

Sunday, May 08, 2011

Is Sapient's 15% Pop A Buy Signal?

Sapient (NASDAQ: SAPE) was a stock star in the 1990s that is among many former high-fliers that have suffered through a tough 11 years. But Friday, Sapient stock spiked 15% to a 52-week high. Does this mean that Sapient's former glory is about to be rekindled?

Back in the last 1990s, I spent some time with Sapient's then senior executive team to research my book, Net Profit: How To Invest and Compete in the Real World of Internet Business. Sapient was among the leaders in the Internet consulting business -- a service to companies seeking the most effective ways to build an e-commerce business. Sapient had a unique process for combining industry and technical expertise to help companies get online quickly and effectively.

The stock went up like a rocket between is April 1996 initial public offering and its August 1999 peak. During that time, Sapient shares rose from $8 to $70 -- growing at a compound annual growth rate of 83.5%. But then the stock slumped and it has spent the ensuing 11+ years below its IPO price. In 2006, Sapient's board tossed out its CEO and CFO in the wake of a stock options investigation that resulted in restating nearly a decade's worth of financial results.

Since 2006, Sapient's revenues have doubled and it has managed to earn a profit in all but one year. More specifically, Sapient reported 2010 revenues of $864 million, 105% higher than its 2006 revenues. And it earned $44 million in net income in 2010 -- an improvement over 2006's $1.4 million loss.

But Sapient's really good news happened in the first quarter of 2011. On May 5, Sapient reported $12.2 million in Q1 net income, up 98% from the previous year. And it made 9 cents a share, 80% more than in 2010.

Sapient also bested analysts' expectations. Its revenues of $249.9 million were $19.1 mil;lion above expectations and 30.4% higher than last year. And its earnings excluding special items of 12 cents a share were 71.4% higher than analysts expected.

Sapient is benefiting from positive trends. First, the Q1 U.S. GDP report revealed that corporate spending on technology was up 11.6% and some of that money is going to upgrade corporate web sites. Second, the weak dollar makes Sapient's value proposition more compelling in international markets.

But does Friday's 15% pop in Sapient's stock a signal that you should buy? To make that decision, you might consider using the price-to-earnings-to-growth (PEG) ratio that compares a stock’s market valuation to its forecasted earnings growth. By that measure, if a stock trades at a PEG of 1.0 or lower, it is reasonably priced. Higher than that, and it looks overvalued.

And based on a PEG of 1.2, Sapient stock is not overly expensive. It trades at a P/E of 43 and its EPS are forecast to grow 36.5% to $0.65 in 2012. It may not be too late to get into this stock because if it continues to beat expectations anywhere near as much as it did in the first quarter, the surprises for investors could be happy ones.

Friday, May 06, 2011

Is There Still Time To Shop For Profit At Men's Wearhouse?

The Men's Wearhouse (NYSE: MW) enjoyed an eye-popping 15% spike in its stock Thursday. The question for investors is whether the company will continue to surprise on the upside or its best days are behind it.

Men's Wearhouse sells suits and its CEO spends quite a bit of his money on telling TV viewers that he guarantees customer satisfaction. George Zimmer's confidence in that claim reminds me of Dos Equis beer's Most Interesting Man in the World. And Men's Wearhouse's first quarter earnings forecast -- it will report on June 8 -- certainly suggests that confidence has its rewards.

Men's Wearhouse operates over a thousands stores -- mostly in the U.S.. Specifically, as of January 2011, it operated 1,192 retail stores, with 1,075 stores in the United States and 117 stores in Canada. Its U.S. retail stores are named Men’s Wearhouse (585 stores), Men’s Wearhouse and Tux (388 stores) and K&G (102 stores) in 47 states and the District of Columbia. Its Canadian stores are known as Moores Clothing for Men in ten provinces. Men's Wearhouse operates a retail dry cleaning and laundry operations through MW Cleaners.

The rewards of its confidence are evident in its announcement of a big boost to its earnings expectations for the first quarter of 2011. Specifically, its new Q1 GAAP diluted earnings per share (EPS) estimate ranges from $0.46 to $0.49 -- that's between 59% and 69% higher than the previous of $0.29. The upside surprise flows from positive consumer response to its so-called value offerings. The result was that revenue rose 10.8% at its Men's Wearhouse stores, 9.3% at its K&G stores and 6% at its Moores Canada stores.

Is Thursday's good news, the propelled Men's Wearhouse stock to a 52 week high, sufficient to warrant a buy order? To make that decision, you might consider using the price-to-earnings-to-growth (PEG) ratio that compares a stock’s market valuation to its forecasted earnings growth. By that measure, if a stock trades at a PEG of 1.0 or lower, it is reasonably priced. Higher than that, and it looks overvalued.
 
Based on PEG of 1.67, Men's Wearhouse looks expensive. After all, it trades at a P/E of 25 and its earnings are forecast to grow 15% to $2.08 in 2012. If you look at the last five quarters, Men's Wearhouse has surprised on the upside by an average of 28.5% -- but that masks big differences each quarter. So that 2012 estimate could be on the low side.
 
On the other hand, Men's Wearhouse has been sued for issuing false guidance.  According to its most recent 10K, it is facing a lawsuit, Material Yard Workers Local 1175 Benefit Funds, et al. v. The Men’s Wearhouse, Inc., Case No. 4:09-cv-03265, alleging that it "issued false and misleading press releases regarding its guidance for fiscal year 2007." Maybe Men's Wearhouse has mended its ways or maybe yesterday's announcement is not what it seems.
 
And Men's Warehouse has a pretty big debt payment coming up within the next year that exceeds the amount of cash on its balance sheet. More specifically, it will need to repay $162 million worth of its $746 million in debt within the next year. And it had a mere $136 million in cash on its balance sheet in January, down $50 million from the year before.
 
Nevertheless, I think at a PEG of 1.67, the potential for upside surprise may already be factored into the stock.