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.
Has Nightfall Beset Sun Microsystems?
Tech stocks have rallied nicely since the November 2nd presidential election, presenting some attractive exit points for certain stocks. Network computing giant Sun Microsystems (SUNW) appears to fall into that category. Over the last three months, SUNW shares have jumped more than 40 percent from under $4.00, hitting a high of $5.60 each this past week. Looking at the company's current valuation, it's difficult to make the case that the stock should continue its ascent. Wall Street analysts seem to agree. While I usually will opt not to side with the consensus view, the current ratio of buy, hold, and sell ratings stands at 3/15/6.
Despite a healthy balance sheet with more than $3.5 billion in cash (approximately $1 per share), Sun's enterprise value-to-earnings ratio looks insanely high, mainly because the company is having trouble turning more than a slight profit on its nearly $12 billion in annual sales. For fiscal 2005 (ending in June), SUNW is expected to earn $0.06 per share or $200 million in profit. This 1.7 percent net margin gives the stock a P/E of 76x, even if we use the company's enterprise value ($15.2 billion) instead of its entire market cap ($17.5 billion).
Even if we were to assume that Sun Micro could raise those margins substantially through cost-cutting, it is still very hard to justify the stock's current valuation. Estimates for fiscal 2006 stand at $0.12 in earnings per share (3.4% margins on $12 billion in sales) give SUNW an enterprise value-to-earnings multiple of 38x. Assuming an overly bullish 5% margin gets you to $0.20 in EPS, but then the multiple only shrinks to 25x, which seems about as high as Wall Street could rationally justify.
All in all, investors seeing value in the $5+ share price of this former tech bellwether may well be being influenced by the share price, rather than actual "financial value."
IBM's Loss is Dell's Gain
Rumors of IBM (IBM) exiting the personal computer business have been confirmed with the PC giant selling its $10 billion-a-year business to China-based Lenovo for $1.75 billion in cash and stock. Margins on PC's are terrible, so this a clearly a good move for IBM as far as profitability is concerned. The stock has moved up on the rumors, but don't expect IBM shares to return to their former glory. The company is so large that the bottom line effect won't be gigantic by any means.
The PC market continues to see the number of suppliers dwindle. Compaq merged into Hewlett Packard, eMachines was bought by Gateway, and now IBM is gone as well. All of this bodes well for industry leader Dell Computer (DELL). Dell hasn't had any trouble increasing its market share in the face of mass competition, but fewer of them surely can't hurt. Michael Dell continues to execute flawlessly, with his company's latest focus, printers, racking up huge sales already.
Dell stock has been on a tear ever since they reported a blowout quarter several weeks back. Even after the run, the stock doesn't look terribly expensive. After accounting for the company's net cash, DELL shares trade at 25 times 2005 estimates of $1.56 per share, with sales expected to rise 16 percent in the coming fiscal year. Any pullback would make Dell shares even more attractive.
Merck Cuts 2005 Guidance (We warned you!)
Just to follow-up the piece I put out here about a month ago on embattled pharmaceutical giant Merck (MRK), here's an update on what the company said this morning. Merck cut its 2005 earnings guidance to $2.47 per share (their range is $2.42-$2.52), citing the withdrawal of Vioxx. Consensus estimates had been for a profit of $2.57 for next year.
Last month, I suggested that 2005 estimates might prove tough to hit (analysts estimated $2.60 per share at that point). During today's conference call, the Company failed to mention anything about setting aside reserves for Vioxx-related litigation. Merck will have to address this at some point in the new year and many believe they will have to allocate $10-$20 billion to settle claims.
The company remains adamant that it will not cut the dividend, which stands at $1.52 per share. This still seems unrealistic given the need for Merck to set aside reserves and also continue its R&D in order to replace, not only Vioxx revenue, but also Zocor when its goes off patent in 2006. Maintaining a payout ratio of 62% ($1.52/$2.47) seems like a poor use of cash flow. Once management realizes this, the dividend will be the first thing they cut.
Sirius/XM Valuations Top Clear Channel
December 7, 2004. Mark it down. Today's the day when the combined market values of XM Satellite Radio (XMSR) and Sirius Satellite Radio (SIRI) reached $20 billion for the first time, topping that of terrestrial radio giant Clear Channel Communications (CCU), which Wall Street values at $19 billion.
Sirius and XM have about 3 million subscribers, a number expected to hit 30 million within 10 years. Investors really have no idea if that estimate will come to fruition, and if it does, how much revenue (and more importantly, profit) these companies will be generating.
What we do know, however, is what Clear Channel has that warrants a $19 billion market value. As of 12/31/03, CCU employs more than 35,000 people, owns 1,200 radio stations along with 39 television stations. They also own about 800,000 outdoor advertising billboards worldwide. CCU owns and/or operates more than 100 live entertainment venues across the globe. Cash flow, measured by EBITDA, for the last 12 months totaled $2.4 billion. Sales for 2004 should hit $9.5 billion, with net income reaching $800 million.
This comparison reminds me of the 1999-2000 bubble days when Priceline.com (PCLN) was worth more than the entire airline industry and AOL bought Time Warner.
Now, its true that 10 years from now SIRI and XMSR could prove to have been bargains at current prices. However, just be aware that today's investors are not paying any attention to valuation (mainly because at this point we have no idea how much these companies will ultimately earn), and as a result, they are basically rolling the dice rather than investing in a business.
That said, individual investors seem to think their odds of profiting from satellite radio stocks are far better than the Powerball lottery or a craps table in Vegas. If you want to short these stocks, based on a valuation that cannot be justified, please restrain yourself. The momentum here is too strong in the short term for valuation to play a role. We've seen this as the stocks continue to rise in the face of multiple analyst downgrades based on valuation concerns.
Unlike the late 1990's, the analysts are now doing their jobs correctly by warning that current prices don't make much financial sense. So, it seems most have learned their lessons. However, as those of us who have followed the markets for many years know all too well, even when analysts are doing their jobs, investors can't rely on their recommendations to make money. On that front, nothing has changed this time around.
Insider Selling Hit 4-Year High in November
Corporate insiders sold $6.6 billion worth of company stock in November, an increase of 187 percent from the prior month. This amount was the highest recorded in a single month since August of 2000 ($7.7 billion). For every $1 of stock purchased by insiders in November, $46.45 worth was sold. The largest group of sellers came from Charles River Labs (CRL), where 14 insiders sold nearly 800,000 shares, netting $36.7 million in the largest round of selling for that company in 5 years.
Historical evidence has shown that insider buying is a much better indication of equity valuations, when compared with insider selling. However, this statistic still indicates to me that stock prices, in general, are likely to be relatively fairly valued at this point in time. It appears that individual stock selection will be crucial in 2005, as the broad market indices aren't likely to appreciate too much from here, given that the S&P 500 is slated to book an 8 percent earnings gain next year and the index trades at a forward P/E of 17.
One notable insider purchase was that of Washington Mutual's CEO, who bought 50,000 shares of WM stock at $39.50, his first open market purchase ever and the largest in the company's history.