Market Volatility Is Back, And That’s Okay

You might be freaking out now that the U.S. stock market has dropped more than 8% during the first two weeks of 2016. With only nine trading days under our belt (including today) it has been a rough start to the new year. It has not helped our mental conditioning that from 2011 to 2015 we had a four-year stretch of no market corrections. Over the last six months we have now seen drops of 10% or more on two separate occasions. It also does not help that the national news typically only covers the stock market on days when the Dow drops 300 or 400 points, rather than giving equal time when it rebounds.

All of this is going to be okay. The shift from human to electronic trading has allowed computers to take over the process, which means much faster transacting. The result is that moves up and down now happen much more quickly. Market shifts that once took week or months can now come and go in a matter of minutes or hours. A 10% market correction might have taken three months a couple decades ago but now can take three days.

The ever-changing global economy also contributes to the volatility. We never heard much about China twenty years ago but now our financial markets can react violently to swift declines in Chinese stocks, even when their impact on American companies is minimal. As the United States matures and other countries grow faster and contribute a higher portion of global economic output, we become less shielded from international markets and therefore we will feel more ripple waves. And that’s okay.

Advances in technology more generally have also had consequences for those of us who are investing for our futures. Information can now be transferred across the globe in a matter of milliseconds. While that is great for a level playing field and means we can research our investments more quickly, easily, and cheaply than ever before, it also means that there is more to react to. More information and quicker dissemination of that information has its drawbacks; namely volatility. Engineers are now even programming computers to automatically place buy and sell trades based on information delivered online. So not only do we get information faster, but we can act on in it much faster too.

And then there are new financial products being created all of the time. More ways to “play” means more money flowing in different directions, which also increases volatility of the underlying prices for assets. As the great new movie “The Big Short” conveys so well, financial derivatives allow more money to be wagered on various outcomes than ever before. As the analogy goes, you used to be the only one who could buy insurance on your own house or car, but now an unlimited number of people can do so. Imagine how volatile the price of insurance will be when it trades daily and anyone can buy it on practically anything.

By now you are probably thinking that I have changed my mind in a few paragraphs and everything will not be okay. Nope. The saving grace is that business profitability does not swing nearly as much as asset prices do. And over the long-term asset prices are going to track the underlying fundamentals of a business. As long as we are willing to not panic and sell when things turn south for a little while, the near-term price gyrations should not matter. And no matter how hard it is to accept this fact and not panic, that is what investing requires. I try to do the best job I can reinforcing this with my clients, but it is a tough job. Emotional reactions are natural and difficult to ignore.

My focus right now is on fourth quarter earnings reports and 2016 commentaries which are getting under way. Doing so will allow investors to separate what is going on daily in terms of asset prices and how the underlying fundamentals of companies look. After all, five years from now stock prices will reflect underlying earnings more than anything else. Five days or five weeks from now they can reflect anything at all.

PS: Some people may argue with that last point. After all, if markets get wacky five years from today what is to say that the underlying profits of the company will matter? That is a fair statement, to some extent. I think it is important to point out that history has shown that stock prices, while volatile, do not have an unlimited range of outcomes. The S&P 500 has traded as low as 7-8 times earnings during periods of double-digit interest rates and as high as 25-30 times earnings during bubbles. But it has never traded for 3 times earnings or 100 times earnings.

Why is this important? Let’s say you buy a $100 stock today that trades for 10 times earnings and pays a 5% annual dividend. Your underlying investment thesis is that it will grow earnings per share by 10% annually for the next five years and continue to pay the dividend, which will be increased at the same rate as the underlying earnings grow.

If your fundamental analysis of the company turns out to be accurate, and you do not sell the stock (even during times of market panic), five years from now you will have collected more than $30 per share in dividends and the company’s earnings will have grown from $10 to $16 per share. Assuming this plays out, what is the worst case scenario in terms of investment return? Even if the stock trades at only 7 times earnings, the stock will still trade at $112 per share. Add in the $30 of dividends you collected and your total return would be more than 40% over a five-year period, or about 8% annually.

Simply put, you are not going to lose money on that investment, as long as your thesis about earnings and dividends is right. This is important because we could not say the same thing if we only look out five weeks or five months into the future. If the stock drops to 7 times earnings in the short-term you would lose 30% on paper even if the company’s fundamentals were on track. As long as you do not overpay for something, being right on the fundamentals and holding for the long-term becomes a winning proposition. That is why I spend the bulk of my time researching companies and hammering home the long-term nature of my investments.

Even With New E. Coli Cases, Chipotle Shares Not Yet Cheap

Shares of casual dining chain Chipotle Mexican Grill (CMG) have been hammered since reports of E. coli outbreaks across the country have caused a material decrease in customer traffic during the fourth quarter (double-digit same store sales declines have been confirmed by the company). After peaking at more than $750 in August, the stock now fetches a little more than $500 per share.


This is definitely the kind of short-term sell-off I pay close attention to as a long-term, contrarian investor. History tells us that restaurants dealing with outbreaks like this see a drop in customer visits but eventually recover. Within a year or two, after the headline news has abated and the health issues rectified, people revert to their previous dining habits. With a perennially high valuation stock like Chipotle, a negative event like this can often be one of the only ways investors can get a bargain for their portfolio. So am I loading up on the shares at the current ~$520 price?

Not yet. Simply put, I don’t find the price extremely compelling, even after a 30% decline. Before the E. coli cases came about, Chipotle was having quite the year from a financial standpoint. Revenue was tracking at about $4.7 billion for 2015 (+15%) with operating cash flow approaching $800 million (about as high a profit margin as you will find in the industry). I estimate maintenance capital expenses for the company’s existing restaurants to be quite low (less than $100 million annually), so CMG’s existing units were on pace to produce free cash flow of $700 million per year before the outbreaks.

The problem for value investors like myself is that the stock’s valuation has gone from insanely high ($24 billion at the peak, or about 34 times free cash flow) to a lower level today (23.5 times free cash flow) which is still fairly high. Despite CMG’s growth outlook, I would have valued CMG at 20 times free cash flow before the recent drop (~$450 per share). Now that customer traffic has dropped more than 10% and will likely take at least a year to recover, I would want a discounted price to reflect the time it will take for the company to fix the problem once and for all and see visitors return to their normal habits. A 25% discount would mean a stock price in the 330’s. Accordingly, I do not think I will be bottom-fishing in CMG shares anytime soon. There are just too many other restaurant chains that I think are meaningfully more attractive from a valuation perspective.

Full Disclosure: No position at the time of writing, but positions may change at any time

CEO Steve Wynn’s Huge Purchase Reinforces That Wynn Resorts Stock Is Dramatically Undervalued

Wynn Resorts (WYNN) announced on Tuesday evening that its Founder, Chairman, and CEO Steve Wynn purchased more than 1 million shares of stock on the open market between December 4th and 8th, bring his total ownership to more than 11 million shares (about 11% of the company). The stock reacted well today to the news, rising $8 to around $70 per share.

I posted earlier this year about my belief that shares of WYNN are very undervalued. After peaking at $249 in March 2014, I began to get interested below $110 in the spring and have been averaging down my clients’ average cost basis during the stock’s swoon.  Wynn’s purchases this month took place when the stock traded between $60 and $66. This insider buy is interesting on multiple fronts. Let me touch on some that come to mind.

1. Owner-operators like Wynn typically sell their shares over time

Founders who continue to run their companies often have large equity stakes. In most instances these folks will sell shares steadily over time for diversification purposes. What makes this transaction so notable is that Wynn already owned 10% of the company (worth nearly three-quarters of a billion dollars) and yet he still bought more stock. This is rare. Think of the times we have heard about the likes of Bill Gates, Mark Zuckerberg, or Jeff Bezos trade in their company’s stock. They almost always sell.

2. Most insider buys are small

Although it doesn’t happen as much as one might hope, when CEOs buy shares in their own company (in the open market with their own cash, not via exercising stock options) the buys are typically relatively small compared with their actual compensation. These kinds of trades are seen by many investors as merely token purchases made for the sake of optics (as opposed to a large financial bet). If a CEO who makes $5 million per year buys $500,000 or $1 million worth of stock once every 5 or 10 years, that hardly signals to investors that they really think it’s a great investment. Wynn’s purchase of 1 million shares is unusual in this respect as well. He spent more than $60 million of his personal funds. That is a lot of money (even for Wynn, who is much wealthier than the average CEO). Think about all of the things he could have bought with $60 million. While it is clear speculation on my part, I think Wynn actually made this move with financial motivations first and foremost.

3. What does this move say about the intrinsic value of WYNN stock?

So why did Wynn buy stock now? After such a huge drop (75% from the peak less than two years ago), should we assume he didn’t think it was undervalued until now? Why not buy at $150 or $100? Did he think the shares were fully valued at $75 or $80? Again, this is pure speculation, but if you buy into my argument that he already has plenty of shares, even if he wanted to signal a vote of confidence he could have done so with a far smaller buy (even $5 million would have been far more than most every other CEO purchase). I would guess that Wynn made this particular move because he thinks the stock’s decline had simply reached “ridiculous” territory. If he is making this investment simply to make money, and he thinks the stock price now is irrational, then why not make a big bet on that view? Conversely, if he was simply trying to stem the stock’s decline with a headline, why not do so after the stock fell by $100 per share? What about after it fell by $150? Instead he waited until it dropped by nearly $200 per share. Why? My guess: because it’s just too darn cheap to ignore, even when you already own 10 million shares.

4. How does my view of the stock change with this news?

It doesn’t. I thought the stock was materially mispriced the day before the news hit and I feel the same way the day of the announcement. Will I load up on even more shares now that Wynn is buying? Probably not anymore than I would have already. While his confidence is a positive signal, it’s pretty hard to objectively argue that the stock has not been undervalued for quite some time. The fact that Steve Wynn likely has the same opinion should not come as a surprise.

5. Should investors jump in now, based on this news?

Wynn stock popped 13% on this news, probably mostly due to short covering. In most instances moves like that are short-lived, either because the news is forgotten in a matter of days, or because the next material news item for the company will likely be deemed more important. I would guess that the stock gives up much, if not all, of this pop over the coming days and/or weeks. After all, the next big catalyst for the stock is the opening of the new $4.1 billion Wynn Palace property on the Cotai strip, which has been pushed back from the end of Q1 2016 to the end of Q2 2016. Until then, the same concerns that have plagued the stock for the last year (the huge slowdown in Macau gaming revenue) are unlikely to abate.

Full Disclosure: Long shares of WYNN at the time of writing, but positions may change at any time

Sorry Goldman Sachs, Apple Is A Hardware Company Plain and Simple

Shares of Apple (AAPL) are rising $3 today to $116 after Goldman Sachs added the stock to its “conviction buy list” and raised its price target to $163 per share (from $145). Goldman’s thesis is that Apple is transitioning from a hardware company to a recurring revenue services business, which will allow it to garner a higher earnings multiple on Wall Street (which in turn would lead to meaningful price appreciation). While many of my clients are long Apple stock, I don’t buy this “Apple is really a software company” argument.

If we take a look at the numbers it is hard to argue otherwise. In fiscal 2015 Apple derived 9% of its total revenue from services, with 91% coming from hardware (led by the iPhone at 66% of sales). Okay, so Apple is a hardware company today but maybe the services segment is growing so fast that it will ascend quickly to be a huge part of Apple’s business? In fiscal 2014 services represented 10% of sales. In fiscal 2013 it was 9%. The mix isn’t changing at all.

So what services business will really start to grow in the future and allow this software thesis to play out? Goldman Sachs, among many others, point to Apple Pay. Apple’s receives a cut of every credit card transaction processed through its Apple Pay iPhone app (the press has reported the rate to be 0.15% but Apple will not confirm this). So if Apple Pay continues to gain market share in credit card processing, will that make a big difference to the company’s financial results? Not at all.

Total U.S. credit card volumes are staggering; more than $2 trillion per year. Let’s be optimistic and say that Apple Pay can grab 25% of all credit card transactions. The result would be about $900 million of Apple Pay service revenue. That sounds like a lot of money until you realize that Apple is booking more than $230 billion of sales annually. An extra $900 million comes to less than one-half of one percent of incremental sales. Even if we model that as 100% profit, it would add just 16 cents to Apple’s annual earnings per share. It’s a rounding error.

The bottom line is that Apple is a hardware company. Could that change in 5-10 years? Perhaps, but it’s not going to happen anytime soon and as a result, investors should not expect the company’s P/E multiple to expand materially. That is not to say the stock won’t perform well, I just don’t think it’s going to trade at or above the valuation of the S&P 500 index, which would be required if the stock is going to see $163 anytime soon.

Full Disclosure: Long shares of Apple at the time of writing but positions may change at any time.

Whole Foods Market: 2015 Update

It has now been about 18 months since I began accumulating shares of Whole Foods Market (WFM) in the high 30’s. Since that time the stock briefly had a huge move back into the 50’s before losing steam again. Same-store sales have decelerated but my investment thesis remains unchanged; just because competitors are copying WFM’s model and seeing success does not mean that the company cannot continue to be the leader in the healthy food space. Investors were not pleased with WFM’s quarterly earnings report last night, but the stock is finding some support around $30 and might be forming a bottom.

So how bad are things really? Well, if you only look at the stock you might conclude the company is all but dead. For instance, traditional supermarket chain Kroger (KR) now fetches a higher relative valuation (cash flow multiple) than WFM, despite the fact that they have more than 2,600 stores nationwide compared with 431 for Whole Foods. Yes, investors think Kroger will deliver better financial results going forward. I don’t suggest taking that bet.

The financial media has concluded that WFM’s troubles are due to people shunning their stores for the likes of Wal-Mart, Target, Costco, and smaller, regional WFM copycats since all of those places now sell organic food. While this may be true to some extent (especially with local WFM wannabe stores — not many Whole Foods shoppers frequent their neighborhood Wal-Mart), there are other explanations that are ignored because they are not as obvious and do not make for interesting headlines.

A big one is the fact that Whole Foods is cannibalizing itself by continuing to open new stores at a rapid pace (32 in the just-completed fiscal year). In Seattle, where I live, there are now 7 Whole Foods stores, with several more in development. Over the last 6 years WFM has increased their store count by 50%. As soon as a new store opens that is 10 minutes away, people are going to stop traveling to the one that is 20 or 30 minutes away.

Interestingly, the company provides information about its store performance based on the age of the store. If the media was 100% right and people were simply switching from Whole Foods to Target or Kroger, sales at all WFM stores would suffer equally. But look at the data for fiscal year 2015:

Store Age       SSS

<5 years         +7.6%

5-11 years       +1.5%

>11 years        +1.1%

ALL                 +2.5%

The older the store, the worse the sales growth. This makes sense, right? If there has been a store in your neighborhood for a decade, chances are you will already be shopping there if you are at all interested in doing so. It’s very hard to boost sales at older stores, especially considering that Whole Foods stores already sell far more food per square foot of space than any other grocer.

And when they open new stores those stores do well for many years, at the expense of the older stores. Existing WFM shoppers will migrate to the closer location (hurting older store sales) and shoppers that had no interest in driving longer distances just to shop there might check it out now that it is more convenient to do so.

Notice that none of this has anything to do with the fact that Safeway now sells Annie’s fruit snacks.

Accordingly, the investment thesis for WFM must incorporate the fact that growing same store sales for the company’s existing base of 431 stores is going to be very hard. In fact, I am assuming that they cannot post sales gains above inflation, which implies flat traffic growth for all stores after they have been open for a few years. So why invest?

First of all, the company has 431 stores vs over 2,600 for Kroger, so it is entirely plausible that Whole Foods ultimately reaches their 1,200 store goal in the U.S. And secondly, the company’s stores are massively profitable even if sales do not grow. For all of the heat the company has gotten lately, fiscal 2015 same store sales actually grew 2.5% and operating cash flow totaled more than $1.1 billion. That’s more than $2.6 million of cash flow per store. For comparison, Kroger does about $1.6 million per store, and their stores are bigger.

At $30 per share, Whole Foods stock trades at less than 8 times EBITDA and less than 14 times existing store free cash flow, both below their less impressive competitors. Such a price would only be justified if the company had minimal growth ahead of it.

Lastly, I cannot conclude without commenting on some of the odd analyst questions from last night’s quarterly conference call. More specifically, the investment community is criticizing the company’s decision to borrow money (they have never had any debt before) to buy back stock aggressively over the next few quarters.

Normally, companies are mocked for buying back stock as it hits all-time highs and then halting the purchases when things turn sour. Despite the fact that WFM did not start buying back any stock until last year (after it dropped dramatically) and now is accelerating those purchases (as it is hitting levels not seen since 2011), everyone just seems to want to pile on. Here is the first question from the conference call:

“Thanks for taking my question. So my one question has to do with share buybacks. I just wanted to understand the rationale for taking on debt and buying back shares right now maybe instead of waiting until maybe comp trends stabilized. So if you could maybe help us with your thought process.”

I was shocked at this question. Whole Foods has no debt, more than a half a billion of cash in the bank and stores that generate over $1 billion of cash flow per year, so they are in pristine financial shape. The stock is hitting 4-year lows and trades at a discount to traditional supermarkets despite being far better in terms of sales and profits. And the analyst wants them to wait until business gets better before buying back stock?

It should be obvious why they are doing this. Because they know if they can improve the business at all going forward the stock is going to go up a lot. Buy low, sell high, right? In fact, if they took Oppenheimer’s advice and waited until the stock was $50 before doing any repurchases, they would probably get mocked for doing so. This just tells me how negative the sentiment is for Whole Foods Market right now.

I may have been early last year with the stock in the $37 area, but since I invest with a five year horizon I am happy to average down and wait for the water to warm up. Right now the company is getting absolutely no credit for what they have built, how successful it continues to be even today, or any future growth opportunities that exist. It is the epitomy of a contrarian, long-term investment.

Full Disclosure: Long shares of WFM at the time of writing, but positions may change at any time.

As Expected, Anheuser-Busch InBev Makes A Big Move Targeting SABMiller

The timing of my last post in June about the odds of Anheuser Busch InBev (BUD) making a big splash in the M&A market was pretty good it turns out. BUD has made a formal approach to SABMiller and I would peg the odds of a deal at no less than 75%, conservatively. While BUD’s slow pace was baffling to me, in hindsight it appears maybe they were waiting for a global stock market correction to help them offer a big premium. Opening with an offer of $65 per share when SAB stock was at $60 would look a bit insulting. With the stock at $47 before today’s announcement, it would get the two sides talking for sure.

Even after major anti-trust concessions such as the sale of SAB’s 50% stake in the Miller Coors joint venture, BUD investors would be material winners if the two beer giants combine. The InBev playbook has always been about lean operational excellence and BUD’s EBITDA margins are well ahead of SAB’s (the gap is more than 10 percentage points, even after subtracting the U.S. operations). After a few years of deal integration the SAB business would likely have similar margins to legacy BUD, which would mean EBITDA accretion of a couple billion dollars. Apply a 13 multiple to that and you get about 15% accretion for BUD shareholders. My fair value estimate for BUD pre-deal is in the high 130’s, which would likely get pushed over $150 after a successful SAB integration.

We could be looking at 2018-2019 as far as a timeline is concerned for such an integration, but given the shaky global economy right now, the risk-reward for BUD investors was very solid before today’s announcement and the numbers would only improve if a deal gets done. As a result, I am not a seller of BUD here and would not be opposed to opportunistic buying depending on how negotiations go. I’ll post an update digging into the deal specifics if one is agreed to over the next couple of months.

Full Disclosure: Long shares of BUD at the time of writing, but positions may change at any time

This Market Correction In Perspective

One of my jobs as a financial manager for individuals and families is to put things into perspective, especially during times of short-term market distress, which can be quite stressful for the average person. In recent years I have tried to regularly remind my clients that normal stock market corrections of 10% or more occur about every year or so over the long term. Since we had not seen one since 2011, it had been four years since investors felt a near-term shock to their portfolios, which made being prepared for the next one especially helpful.

Given how much day-to-day stock market activity is computerized these days, one thing that is different now is that market moves happen more faster than they used to. What previously had taken weeks and months to take shape now can come and go in a matter of days. As I write this, the S&P 500 index is trading at 1,912, which is 10.4% below the all-time high made back in May. Amazingly, 8.8% of that decline has come in the last 4 trading days.

So what is important to keep in mind as computers send the market into a new world of volatility? Keep things in perspective. This  can often most easily be accomplished with graphics, so below I present three charts of the S&P 500 index:

Here is a year-to-date chart for 2015 which shows the current, sharp 10% decline:



Granted, that might look and feel kind of scary on its own.

Now, to see how far we have come and how much we have declined on relative terms, here is a 5-year chart:


I would guess that this second chart is far less scary to most people. It shows the market having more than doubled over a five-year period, includes the last major correction in the market (August 2011), and the most recent period appears to be no more than a standard, run-of-the-mill correction in stocks.

The last chart might be the most interesting, as it goes back 10 years. I included this one because it includes the last market peak before the “Great Recession” decline of 2008:



Even after the last week of declines, the U.S. stock market is still considerably above the peak it reached in 2007, just before the second largest economic collapse in United States history.

None of these charts can predict how the market will fare over the coming days, weeks, or months. Hopefully it does put the last decade in perspective and show that what we are experiencing right now, while not fun, is neither out of the ordinary, nor overly disconcerting. If you are retired, the plan you have in place with your financial manager is likely unchanged, as it should have incorporated the likelihood (or certainty, more precisely) of normal, periodic market declines. If you are still in the “work and save” phase of your career, times like these are a great time to add to your investment portfolio, as great companies are on sale.

Bargains Are Everywhere For Long-Term Investors, Even With S&P 500 Losses Contained Thus Far

Based solely on the number of new stocks I am finding to be priced at bargain levels, one would think the U.S. stock market has broken its years-long streak of avoiding a 10% correction. My potential buy list of stocks has not been this full in a long time, even though the S&P 500 (trading at 2,050 right now) has only dropped 4% from its all-time high. The reason is that as the current bull market continues to age, it is being led by fewer and fewer companies. Take out some high fliers like Amazon (AMZN) and Netflix (NFLX) and the underlying performance of the market overall has been pretty weak this year, and this is causing individual stock pickers to have ample choices when allocating fresh investment capital.

Take Disney (DIS), as an example. Down $6 today alone, the stock now fetches $100 per share, versus the $122 new high it reached on August 4th, just 16 days ago. For a blue chip company like Disney, which was a market darling just weeks ago, to be down 18% from its high is pretty remarkable. These are the kinds of moves we typically see when the market indices are really taking it on the chin.

It is impossible to know if the high-fliers are going to keep the S&P 500 fairly buoyant, or if we really will see a normal correction in the market (which would have to take stock prices materially lower from here), but as a long-term investor I do not especially care either way. I tell my clients that I invest in companies with every intention of holding them for at least five years. There are certainly times when I sell before that, but when you are searching for contrarian bargain opportunities you want to have time on your side since investors’ daily emotions are so unpredictable and oftentimes irrational. So when I find great investment opportunities, as I am more and more these days, I do not hesitate to start accumulating shares, even though the market is overdue for a correction and only down 4% from its high. If my investment thesis is correct, and I am willing to hold the stock for five years, the short-term noise becomes irrelevant.

As you consider whether to add fresh money to your investment accounts (and when), keep that in mind. Buying a good company at a great price usually pays off very well for long-term investors, in any market environment. Assuming that environment is similar to today when I write my next quarterly client letter in early October, I am likely to encourage my long-term investor clients who are still regularly adding cash to their accounts to prepare a plan of attack. That might mean putting some money to work now and leaving some on the sidelines in case we get a bigger market drop, but at the very least I think we should be shaping our plans around what we are seeing out there right now. And I would characterize the market today as getting very interesting on a stock specific level, provided one has patience and is focused on company fundamentals and not day-to-day market noise.

Full Disclosure: Long AMZN, DIS, and NFLX at the time of writing, but positions may change at any time.

Noodles and Company Update: I’m Turning Bullish

My first post about casual dining chain Noodles and Company (NDLS) was on the company’s IPO day in June 2013. Fast casual restaurants were very hot and NDLS took advantage of that with a very well-timed initial public offering at $18 per share. That first day the stock doubled and I tried to caution people that the valuation made little sense, despite the company’s growth prospects (link: Noodles and Company IPO Doubles in Price, Already Overvalued After One Day).

The stock continued to soar for a little while, peaking at $51.97 a month after the IPO, but it has been an ugly downhill slide ever since. In August 2014 I wrote a follow-up post as the stock dipped below $20, highlighting that I thought it was still too high, but situations like it are worth monitoring (link: Noodles and Company Falls Back to Earth, Still Not A Bargain). The reason is because many of these companies are profitable and growing and therefore are not bad investments, provided the price is right.

In the case of NDLS, the stock hit a new low of $11.37 on Friday and can be had today for $12 and change. That is down 75% from its high and nearly 1/3 below the original IPO price of $18 per share. So is it finally a bargain? I think so. At current prices the company trades at less than 1 times annual revenue. Add in solid cash flow generation from existing units and a lot of room to grow the restaurant base over time (unit growth is currently above 10% annually) and I think the stock is quite undervalued. Earnings per share are often depressed on an accounting basis when companies are growing quickly as capital expenditures for building new units flow through the income statement, so cash flow is really the most crucial metric for NDLS. On that basis the numbers look very good.

I estimate that the company’s existing unit base alone is worth approximately $19 per share, so it trades at quite a discount right now in my view. And that does not even include a $35 million stock repurchase plan that the company has authorized and indicated they plan on completing by year-end. It may have taken more than two years since the IPO, but paying attention to the company could very well pay off for those who have been patient.

Full Disclosure: Long NDLS at the time of writing, but positions may change at any time

Yahoo Update: I Might Be The Only Person Who Likes Marissa Mayer’s Turnaround Plan

Nearly three years ago I wrote a bullish article on Yahoo (YHOO) after ex-Google exec Marissa Mayer took over as CEO, with the stock at $16 per share (Does Marissa Mayer Make Yahoo Stock A Worthwhile Bet?). After the stock had doubled a year later I postulated that it was fairly valued, but for a while now I have moved back into the bullish camp. The skeptics point out (correctly) that the stock’s huge run since Mayer’s hire is mostly due to a massive increase in the value of its stake in Chinese e-commerce giant Alibaba (BABA), the last of which will be spun off to shareholders in late 2015 or early 2016.

The consensus view on Mayer’s efforts to reinvigorate the company’s core business is quite negative. Many of the hedge fund activists who pushed for the BABA spin-off have publicly called for Mayer’s exit. While Yahoo’s own financial results remain about where they were when Mayer took over three years ago, the make-up of that business has changed dramatically, which positions the company very well for the future.

Back in 2012 Yahoo’s core business was like a melting ice cube, as user preferences were moving away from both the Yahoo brand and from desktop search. Much to Mayer’s disappointment, the company had hardly any presence in areas like mobile and social media, even though that was clearly where online usage was going. So, Mayer made a big push into what she calls “Mavens” (mobile, video, native, and social). By revamping Yahoo’s mobile apps, acquiring upstarts like Tumblr, and refocusing the company on current usage trends, Mayer’s plan was to expand into areas of growth in order to offset the slowly declining legacy business (conducting internet searches on from a desktop computer is so 1995). Perfectly logical.

Mayer’s critics, however, are unimpressed. Yahoo’s annual revenue dropped from $5 billion in 2012 to $4.6 billion in 2014, as legacy declines more than offset growth in Mavens. Since Mavens started from practically zero in 2012, it is going to take a while for the new businesses to get large enough to overshadow the legacy ones, but when that happens Yahoo can begin to see absolute growth again. Mayer is making a lot of progress on this front. Mavens revenue in the second quarter of 2015 was $400 million, or 1/3 of total company sales, representing growth of 60% year-over-year. The plan is working despite the multi-year timeframe.

But the real reason I am bullish on the stock at current prices ($39) is the fact that Wall Street has basically decided that Yahoo’s core business has no chance of returning to growth, ever. The soon-to-be spun off Alibaba stake is worth $32 billion or $34 per YHOO share (the after-tax value is less — $22 per share — which is relevant if Yahoo cannot get IRS approval for a tax-free spin-off). Add in the market value of Yahoo Japan ($6 per share after-tax) and Yahoo’s current net cash position ($6 per share) and you can see that investors are getting core Yahoo for a pittance. Even assuming a fully taxed Alibaba stake, core Yahoo is valued at only $5 per share (around 1 times current annual revenue). Assume a tax-free spin of BABA and you get a ridiculous figure for core Yahoo’s value — negative $7 per share!

Given the momentum the Mavens businesses are seeing right now, coupled with the $7 billion of cash on the company’s balance sheet (fuel for more acquisitions, perhaps), I actually think Mayer can turn around the Yahoo ship in the not-too-distant future. Paying just $5 per share for the core business even in the worst case scenario makes the risk/reward trade-off  extremely favorable. For investors who are willing to hold the Alibaba stock for the long-term (that company is very well-positioned), I can easily see Yahoo shares being worth over $50 a year or two from now on a cumulative basis.

Full Disclosure: Long shares of YHOO at the time of writing, but positions may change at any time