eBay Earnings Report Rattles Tech Stocks

eBay (EBAY) shareholders are feeling the effects of owning a stock with a 70 forward p/e tonight. With a equity market valuation that high, there leaves little room for error. You won’t be able to find a single person who thought eBay would miss its earnings after the bell today, and as a result the stock fell $15 in early evening trading.

The great thing about Wall Street is that if you managed to avoid having eBay in your portfolio, you can take advantage tomorrow morning when investors throw the baby out with the bath water. It always happens, even when it defies logic. All Net stocks got crushed when eBay’s earnings report came out. Yahoo! (YHOO), Overstock (OSTK), and Google (GOOG) especially. Just decimated.

Why? Because they are Internet companies. Only thing is, just because eBay feels it needs to invest in its business to maintain market dominance (which will lead to lower margins, hence, lower earnings per share), this doesn’t mean anything is wrong at Yahoo!, or Google, or Overstock.

Yahoo! barely even remembers it has an auction site, eBay won that battle long ago. Google doesn’t have auctions. Overstock said this week that it saw a huge rise in its auction listings after eBay announced its annual fee hikes (which were needed even more this year to help prop up falling profit margins). Nonetheless, all of these stocks lost 10 percent of their value just between noon and 5pm, solely due to eBay’s announcement.

The market gives investors these types of opportunities all the time. The only problem is, most investors don’t take advantage of them. They should.

Last Year It Was Interest Rates, This Year It’s Oil

Think back more than a year ago. At the time, market predictions for the coming year centered around one major theme; interest rates. The consensus opinion was drilled into our heads for months, namely that interest rates would have to rise in 2004, and the housing market would cool off. Some even called for the bursting of the housing bubble, even though there wasn’t a bubble at the time that could be burst. Investment strategists warned their clients to avoid stocks of mortgage lenders and home builders.

Believe it or not, the consensus for 2004 was wrong (okay, this is very believable). Despite the fact that the Fed did start raising their lending rate from 1% to 2%, market rates didn’t budge. In fact, in many cases they actually dropped. Mortgage rates were steady, and bond rates fell. What were some of the best performing stock groups in 2004? You guessed it.. mortgage lenders and housing stocks.

Okay, so that is in the past and just serves to prove that the consensus is usually wrong. With 2005 having just begun, what was everyone saying just before year-end, and how can we bet against it this year? Without a doubt the 2005 theme that received the most airtime was oil. After falling from its peak price of $55 per barrel, oil was hovering in the $40-$42 range at year-end 2004, and most were predicting a drop back to a “more normal” $28-$35 per barrel price tag.

So here we are, on January 18th and oil prices hit $49 this morning, knocking on the door of $50 for the second time in recent months. A move down to the high twenties or low thirties would surely ignite the market a bit, and the airline stocks even more dramatically, but don’t count on it. Oil is to 2005 what interest rates were to 2004.

Taser Shareholders Stunned

Let the class action lawsuits begin. It appears the party for stun gun maker Taser (TASR) is ending. Two years ago, TASR stock traded at $0.35 (split-adjusted). After rising to more than $33 in 2004, the stock fell 30% today, to close at $14 per share. Taser is down 55% so far this year, and it’s only January 11th. As a result, lawsuits will be filed, lots of them. And soon, very soon.

Shareholders will scream of being had. Taser didn’t adequately update the public about its business, they’ll say. They will point to the company’s management; a father (Chairman) and two sons (one is CEO, the other is President). The trio sold more than $100 million worth of stock in 2004, all while touting their stun guns’ safety and growth potential to any TV station or reporter that would listen.

They will be accused of insider trading because they were selling stock as they were hyping their company’s prospects. Class action lawyers will conclude they knew business would fall short of their rosy projections, hence they sold, but didn’t tell anyone, leaving shareholders with a 55% loss in 11 days.

Can you blame them? Not the shareholders, they are to blame, but rather Phil, Tom, and Rick Smith. Are they bad people for taking $105 million in profits off the table when their company was being valued at nearly $2 billion, despite only having $68 million in sales? Are they crooks? No. Actually, they are smart. They didn’t know ahead of time when orders would be delayed or exactly when competitors would bring new products to market. What they did know was that companies aren’t worth 30 times revenues very often, and when they are, it’s not for very long.

How about Mark Cuban? Is he a crook? Most people (including myself) think he was a genius when he sold his Internet broadcasting company, Broadcast.com, to Yahoo! for billions of dollars. He got Yahoo! shares in exchange, and even knew to sell those too. Mr. Cuban didn’t sell because he lost interest in his business, or because he doubted whether radio signals would be broadcast over the Internet. He sold because he knew Broadcast.com was not really worth the $7 billion the equity market was pricing it at.

It’s the world we live in today. We do something stupid, lose money because of it, and we sue. We don’t admit we made a mistake and learn from it; vowing never to make the same mistake again. That’s what we should do, but not what most of us will do. Taser shareholders who will choose to join the class action suits are a perfect example.

If you paid 30 times sales for an overhyped pipedream company, you probably will lose money. It happens. We all mess up sometimes. But do yourself a favor. Learn from the mistake. Learn how to value companies properly, so as to avoid losing any more money. But please, don”t sue the people who understood concepts you failed to grasp.

The Smiths may be very guilty of overhyping their company. But not once did they hold a gun (no pun intended) to somebody’s head and force them to buy Taser stock. When they saw an asset they owned become grossly overvalued, they sold. They did what every good investment manager would have done, and is heralded for doing.

We shouldn’t sue people just because they’re smarter than us. I’m not against giving every human being their fair day in court. The problem right now, in 2005, is that we don’t only sue when somebody breaks the law. We sue when we mess up, to get revenge.

Post-Holiday Sale on Kmart Shares

What a difference a few months can make. The morning Kmart announced its $10+ billion dollar acquisition of Sears, its stock soared to nearly $120 per share. Since then, sellers have come in and arbitrageurs have opened short positions. In fact, more than 11 million KMRT shares were sold short in December, up from 8.9 million in November. The stock is down 7 points this year, to its current $92 price tag.

Investors who missed out on Kmart’s run from $15 to $120 are being given a second chance. Naysayers have been very vocal in dismissing the merger’s touted efficiencies and warning about integration risk as the retailers seek to transform their businesses as one cohesive unit, Sears Holdings.

Buyers of the stock in the low 90’s should be rewarded. Many of the shares sold short (21% of the float as of 12/8/04) will be bought back when the merger closes sometime around March of this year. Despite the claim that the combination will be little more than a larger version of a poorly run retailer, Chairman Eddie Lampert and Company will be able to improve operations meaningfully, just like they have done in the past with other retailers.

Also, don’t think real estate sales are over. There continues to be hundreds of millions of dollars in value embedded in Kmart/Sears land that will be harnessed. Post-holiday sales have brought shoppers many deals in recent days, and KMRT at $92 is a prime example of how investors can grab a great deal as well.

December Retail Sales Show Mixed Holiday Results

Today’s market was largely influenced by December same-store sales results released by America’s top retailers. While the holiday shopping season started off slowly, it appears that business overall wasn’t as bad as some thought earlier on. Thursday’s stock market action showed a clear divide between those that did well, and those that did not. Most retailers reported sales growth above consensus, but the stocks reacted violently in both directions.

As is always the case, Wall Street’s obsession with short-term results presented investors with many opportunities today, as retailers were among the day’s most active stocks. Ann Taylor (ANN) shares rallied after getting decimated late last year. Urban Outfitters (URBN) got hit after warning that 15 percent comp store sales gains could not be sustained (did anyone really think they could be?). Aeropostale (ARO) was one of the only teen retailers that did not do well, and a pair of analysts downgraded the shares based on a single lackluster month.

Most investors will sit tight, but they should really be stepping up to the plate. ARO trades at 13.5 times 2005 earnings with growth expected to be 20 percent. Makes no sense. URBN stock is reacting to less-than-expected momentum at existing stores, but their nationwide expansion plans are the reason to own the stock. I added to my position in the latter and initiated one in the former. Volatility like we saw today should make opportunistic investors salivate.

Martha Still Relying on “Insider” Trading

Rough life for Martha Stewart these days, right? Perhaps. But at least she is staying on top of her finances from prison. On December 14th, Martha sold 300,000 shares of her company’s stock, MSO, for a little over $27 each, netting proceeds of $8.2 million. This is surprising, not because selling doesn’t make sense (the stock has rallied from $8 to $33 a share) but because it seems to me that maybe inmates should be prohibited from trading stocks from jail. But what do I know?

A Pair of Growth Stock Ideas for ’05

The majority of investments found in Peridot-run portfolios could be classified as either contrarian plays or undiscovered value stocks. Nonetheless, sometimes there are growth companies out there that look so attractive that even Peridot will be more than willing to “pay up” for them and watch their businesses grow like wild fires over the course of several years.

While forking over 30 times earnings for stocks is rare for us, in recent weeks we have been accumulating shares of small-cap restaurant chain Buffalo Wild Wings (BWLD) and mid-cap clothing retailer Urban Outfitters (URBN). In both cases, the tremendous growth potential over the next three to five years gives us comfort, even though the high multiples of these names make the stocks very volatile.

From a p/e-to-growth rate (PEG) perspective, you can make the case that 30x 2005 estimates is not too high, given that both companies are slated to grow 25 percent a year, for a PEG ratio only 1.2, compared with 2.0 for the S&P 500. If both BWLD and URBN are able to maintain their growth, which we believe they can, there is no reason both stocks cannot hold above-market multiples for years to come. In fact, both of these stock could triple in the next five years, for a compound annual growth rate of more than 20 percent.

The main reasoning for these growth assumptions is the combination of an extremely popular concept, in addition to a relatively small store base in place at the current point in time. Customers are raving about both Buffalo Wild Wings restaurants and all three concepts that Urban Outfitters is rolling out (Urban Outfitters, Anthropologie, and Free People). BWLD owns and operates 290 units, with ab0ut a third of them in the state of Ohio alone. The company sees the potential for at least 1,000 restaurants in the U.S. URBN still only has 71 Urban stores and 62 Anthropologie stores, or fewer than 1.5 of each per state.

As both of these companies continue to grow, in both popularity and sheer size, both stocks should reflect such growth, making them excellent stories to hold for many years to come.

Sprint-Nextel Combo Presents Arb Opportunity

Rumors were made official today as Sprint (FON) and Nextel (NXTL) announced plans for a $35 billion merger, creating a much more formidable number three player in the wireless market. With Verizon and Cingular far larger than #3 Sprint, adding Nextel’s business clients and push-to-talk technology puts the combination right on the heels of the industry’s top two giants.

Nextel had to do this deal in order to avoid spending billions to upgrade its wireless network to the latest technology. Sprint’s wireless clientele is more focused on the consumer side, so this combination will allow for Sprint-Nextel to offer push-to-talk as well as wireless Internet services to both companies’ customers. The merger should net about $12 billion in synergies, according to today’s announcement.

The proposed deal calls for Nextel shareholders (Peridot Capital is one) to receive about 1.3 shares of Sprint for each share of Nextel they hold. A small cash portion (about 50 cents per share) is also part of the transaction. As I write this, FON shares are trading at $24.55 and NXTL stands at $29.66. Nextel trades at about a 7.6 percent discount, based on the deal’s terms, presenting arbitrageurs with an attractive spread.

The deal is expected to close in the second half of 2005 and some are speculating that Verizon or another player may make a rival bid for Sprint, although this seems far from assured (I’d say less than a 50/50 chance). One last thing to keep in mind about the 7.6 percent spread on the deal; Sprint currently pays a 2% annual dividend, so those shorting the acquirer’s stock will be responsible for that payout.

With the S&P Crossing 1200, Gains in ’05 Could Be Limited

The S&P 500 closed today at 1203, its highest level since the third quarter of 2001. The market’s strong rally in the last five weeks clearly has boosted morale on Wall Street, but can we expect this upward move to continue?

Unfortunately, it doesn’t look like the market has a lot more room to run. Earnings are expected to rise about 8 percent in 2005, and the S&P 500 trades at 17.2 times the current $70 earnings estimate for that index, hardly cheap.

If we take an aggressive profit growth forecast of +10 percent for next year, and put a fairly rich 18x multiple on that, we get a 1300 target on the S&P, about 8 percent higher than where the market stands today. Much like 2004, next year should prove to be another solid year for stock-pickers, but an uneventful year for index fund owners.

There are still several issues that could derail continued economic growth in the coming months; sustained $40 per barrel oil, Middle East trouble during the January elections in Iraq, as well as the fear of rising inflation and/or interest rates. All in all, it makes sense to be cautiously optimistic as investors structure their portfolios for the coming year.

Google Outlook Strong for 2005

It will be very interesting to see how Wall Street reacts when Google (GOOG) reports its fourth quarter earnings in late January. If the company exceeds estimates for the second time in as many quarters since its IPO, investors will have to decide why they are assigning Google a lower valuation than its chief competitor, Yahoo! (YHOO). Despite the fact that Google’s total sales and growth rate will likely both pass those of Yahoo! in 2005, GOOG shares trade at 51x 2005 estimates, versus 76x for YHOO. Google’s market value is also more than $5 billion less than Yahoo as I write this.

It seems that the common knock against Google (that it relies too much on paid search and is not as diversified as Yahoo!) could actually help it outgrow the competition next year and beyond. Google’s G-Mail email service is still being finalized before it will be made available to everyone (users now need a referral to sign up for an account). Other new services such as blog hosting (BlogSpot) and shopping (Froogle) are just in the beginning stages of deployment. Conversely, Yahoo! has been diversifying away from search for years (through acquisitions like HotJobs and Broadcast.com).

It is for this reason that I think Google has a better chance than Yahoo! of beating analyst sales and profit estimates going forward. They simply seem to have more avenues for growth since they have been fairly narrow in their focus on search until recently. More upside potential combined with a 2005 price-earnings ratio a full 33 percent lower than Yahoo! makes Google shares look very intriguing going into the new year.

If a long position in Google is a bit too speculative for some investors (understandable given that we are still dealing with a 51 forward p/e), a paired trade of long GOOG and short YHOO can take advantage of any closing of the valuation gap, with much less day-to-day equity price volatility.