Netflix and Tesla: Early Signs of Froth in a Bull Market

It is quite common for a bull market to last far longer than many would have thought, and even more so after the brutal economic downturn we had in 2008-2009. Only just recently did U.S. stocks surpass the previous market top reached in 2007. Although it does not mean that a correction is definitely imminent, the current stock market rally is the longest the U.S. has ever seen without a 5% correction. Ever. Dig deeper and we can begin to see some froth in many high-flying market darlings. Fortunately, we are not anywhere near the bubble conditions of the late 1990’s, when companies would see their share prices double within days just by announcing that they were launching an e-commerce web site. However, some of these charts have really taken off in recent weeks and I think it is worth mentioning, as U.S. stocks are getting quite overbought. Here are some examples:

TESLA MOTORS – TSLA – $30 to $90 in 4 months:


NETFLIX – NFLX – $50 to $250 in 8 months:


GOOGLE – GOOG – $550 to $920 in 10 months:



You can even find some overly bullish trading activity in slow-growing, boring companies that do not have “new economy” secular trends at their backs, or those that were left for dead not too long ago:

BEST BUY – BBY – $12 to $27 in 4 months:


CLOROX – CLX – $67 to $90 in 1 year:

WALGREEN – WAG – $32 to $50 in 6 months:



Ladies and gentlemen, we have bull market lift-off. My advice would be to pay extra-close attention to valuation in stocks you are buying and/or holding at this point in the cycle. While the P/E ratio for the broad market (16x) is not excessive (it peaked at 18x at the top of the housing/credit bubble in 2007), we are only 15-20% away from those kinds of levels. Food for thought. I remain unalarmed, but definitely cautious to some degree nonetheless, and a few more months of continued market action like this may change my mind.

Full Disclosure: No positions in any of the stocks shown in the charts above, but positions may change at any time

Is Priceline’s Stock Valuation Out of Whack with Reality?

Rob Cox of Reuters Breakingviews¬†was on CNBC this morning sharing his view that the stock of online travel company (PCLN) appears to be dramatically overvalued with a $30 billion equity valuation (even after today’s drop, it’s actually more like $35 billion). Rob concluded that Priceline probably should not be worth more than all of the airlines combined, plus a few hotel companies. While such a valuation may seem excessive to many, not just Rob, it fails to consider the most important thing that dictates company valuations; cash flow. In this area, Priceline is crushing airlines and hotel companies.

As an avid Priceline user, and someone who has made a lot of money on the stock in the past (it is no longer cheap enough for me to own), I think it is important to understand why Priceline is trading at a $35 billion valuation, and why investors are willing to pay such a price. While I do not think the stock is undervalued at current prices, I do not believe it is dramatically overvalued either, given the immense profitability of the company’s business model.

At first glance, Priceline’s $35 billion valuation, at a rather rich eight times trailing revenue, may seem excessive. However, the company is expected to grow revenue by nearly 30% this year, and earnings by 35%, giving the shares a P/E ratio of just 23 on 2012 profit projections. Relative to its growth rate, this valuation is not out of line.

The really impressive aspect of Priceline’s business is its margins. Priceline booked a 32% operating margin last year, versus just 4% for Southwest, probably the best-run domestic airline. With margins that are running 700% higher than the most efficient air carrier, perhaps it is easier to see how Priceline could be worth more than the entire airline industry.

Going one step further, I believe investors really love Priceline’s business because of the free cash flow it generates. Because Priceline operates a very scalable web site, very little in the way of capital expenditures are required to support more reservations and bids being placed by customers. Over the last three years, in fact, free cash flow at Priceline has grown from $500 million (2009) to $1.3 billion (2011). At 27 times free cash flow, Priceline stock is not cheap, but given its 35% earnings growth rate, it is not the overvalued bubble-type tech stock some might believe.

Full Disclosure: No positions in any of the companies mentioned, but positions may change at any time

GM Buys Subprime Lender for $3.5B (Some Companies Just Never Learn)

Just when I thought General Motors was on solid footing and heading in the right direction after shedding a large portion of its liabilities in bankruptcy, they seem to have forgotten what has happened over the last several years in the world of credit. One of the big reasons GM’s losses were compounded during the recession was because they funded a lot of subprime loans for their vehicles through GMAC. When those loans went sour, the losses not only negated the razor thin margins they had on the vehicle sales themselves, but resulted in a company that lost money on most of their cars. Hence, SUVs (with their fat profit margins) became a focus for the company, even in the face of rising gas prices, which aided their competitors in stealing market share.

Since GM has exited bankruptcy and the economy has stabilized management has stated publicly a desire to once again expand into the subprime auto finance market, but this time GMAC was hesitant (and understandably so). Undoubtedly, the result has been that GM could be selling more vehicles if they were willing to finance customers with bad credit who could not get loans elsewhere. This morning we learn that for $3.5 billion in cash GM is buying AmeriCredit (ACF), one of the larger subprime lenders in the country. They will use this new financing arm to get more cars into the hands of more people, many of whom could not get loans from third party lenders due to bad credit, no job, etc.

While I am sure those in the industry will praise this deal as a way for GM to maximize unit sales, we need not completely forget how cyclical economies work. Subprime lending pays off when the economy is improving but when the business cycle inevitably turns (as every economy does), the loans turn sour, the losses are crushing, and the cycle starts all over again. To me this highlights one of the core problems our domestic economy has developed over the last 10 or 20 years. We continue to follow the path of loose credit when things are going great and at the first sign of a downturn, credit standards increase dramatically. Once things stabilize, we hear that banks are slowly reducing their standards and loan volumes increase again.

For the life of me I cannot figure out why banks and specialty lenders refuse to maintain the same lending standards throughout the entire business cycle. The idea that lending money to people who are likely to default is good business sometimes and bad business other times baffles me. Sure, the few banks that always make smart loans, despite the economic backdrop, make a little less profit during boom times, but they also weather the recessions quite well in return for such prudence.

This kind of cyclical lending activity from the likes of GM (and most others) only contributes to the boom and bust economy the United States has seen become even more pronounced over the last decade. Fortunately, GM is set to go public via an IPO sometime in the next 12 months, at which time the U.S. taxpayer can shed its majority ownership in GM and therefore no longer be in the subprime lending business.

Update (9:15am)

Here is a 15-year chart of AmeriCredit’s stock price which puts into graphical form the cyclicality I mentioned above.

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

Tesla IPO Hopefully Can Boost New “Green” Economy

From Fox Business:

“Tesla Motors, maker of luxury-all-electric cars, is reportedly planning a stock offering. If the sale occurs, Tesla would be the first U.S. car company to issue shares since Ford Motor Co. in 1956.”

This is very exciting news. Not necessarily from an investment standpoint (it will likely be a while before pure electric car companies can prove to investors they have a sustainably profitable business model), but from an innovation point of view. The United States needs to promote the future of a “green” economy, not just to reduce oil imports, but even more importantly to generate a new force that can produce job growth, much like the advent of the Internet has already done. I hope Tesla has a successful IPO, as it may provide a psychological boost for other entrepreneurs out there who would like to get the “green” ball rolling.

United Airlines: How Not To Run An Airline

I came across this article by John Battelle over on Business Insider and thought I would share it with everyone. I am a loyal Southwest customer so I have managed to avoid the crazy complicated (and irrational) dynamic pricing algorithms that many of the major carriers use. Hopefully there are not too many United shareholders out there reading this…

Thanks For Flying United. Please Give Us All Your Money

Chevy Volt Could Get 230 Miles Per Gallon

This seems like the kind of thing that could get more people into GM showrooms and help them recapture lost market share, even if most consumers do not purchase the new Chevy Volt, due out in late 2010.

According to an Associated Press story today GM announced that the Chevy Volt rechargeable electric car should get 230 miles per gallon in city driving, more than four times the mileage of the current mileage leader, the Toyota Prius.

From the story:

“The Volt is powered by an electric motor and a battery pack with a 40-mile range. After that, a small internal combustion engine kicks in to generate electricity for a total range of 300 miles. The battery pack can be recharged from a standard home outlet.”

Despite a hefty initial price tag (expectations are ~$40,000), the car could still be cost effective. Why? According to the story, “If a person drives the Volt less than 40 miles, in theory they could go without using gasoline.”

If we want to reduce our use of foreign oil in a meaningful way, this is exactly the kind of innovation that could do it. Not only will less of our money go to the Middle East region, but we will be reducing pollution and Americans will be able to keep more money in their pockets by saving on the cost of gas. Count me as very much looking forward to the launch of more electric cars in the United States.

Chrysler, Ford Riding Government Incentives to First Sales Gains in 2 Years

It is hard to argue with the success of the “Cash for Clunkers” automobile incentive program so far. With $1 billion already blown through, Congress is working on a $2 billion extension, despite most Republicans being against the program (probably because it was a Democratic idea, not because it is not working).

So far the average consumer is trading in their clunker for a new car that gets 9 miles per gallon more than the vehicle it replaced. The sales spike during the last week of July has led both Chrysler and Ford to report July sales gains, the first increase in 2 years for the domestic automobile industry. General Motors reported a 19% decline in sales, but still saw an enormous benefit from the program.

It remains to be seen if car sales will be sustained at higher levels, but the glass looks half full at this point. New car inventories are near all-time lows so inventory rebuilding in coming months should boost GDP pretty significantly, perhaps leading to a positive GDP print for the third quarter.

The car companies are not the only beneficiaries, however. “Cash for Clunkers” helps consumers and the country as a whole too. Higher fuel efficiency should not be understated. Consumers will save money by spending less to fill up their gas tanks, freeing up money for other things. In addition, less pollution from the new vehicles not only is safer for Americans but the environment in general as well.

Despite skepticism from many, this program does this show that smart government spending can stimulate the economy. In this case it does so in more ways than one, making the investment well worth the several billion dollars spent.

Full Disclosure: No positions in Ford or GM at the time of writing, but positions may change at any time

After 350% Gain, AutoNation Shares Look Pricey

Typically when I write about individual stocks on this blog I share bullish ideas that I am either long or thinking about going long. I was recently doing some work on AutoNation (AN), however, and since the stock looks pricey to me I figured I would share a bearish case as well.

The reason for a contrarian like me to look under the hood of AutoNation is pretty straightforward. The U.S. automobile industry is obviously struggling right now but AN has strong management and the dealers are in better shape than the car markers themselves (cost structures are more in-line without union obligations, etc). Couple that with strong buy side interest from Eddie Lampert’s ESL Investments and Bill Gates affiliated Cascade Investments and my interest was peaked.

That said, it appears that I missed the boat on AutoNation, at least for now. The stock has soared 350% from under $4 per share to near $18, just below a 52-week high. The stock’s P/E of around 20x is high, but part of that is due to cyclically poor earnings during the current recession.

I looked back at AutoNation’s financial statements for 2006-2007 and found that earnings per share peaked at around $1.45 during the boom years. Even at that level of profitability, AN stock trades at 12 times earnings, hardly a bargain for a slow growing automobile retailer.

AutoNation has a strong share buyback program in place, which is attractive to me, and the auto retail business should slowly improve in coming years, so AN is on my radar screen. However, given the current price and the move the stock has already made (ESL and Cascade timed their buys very well), I am not a buyer here. If we got down to the low teens, perhaps I would take another look.

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

Market Loves GM Bankruptcy

I kid, of course. The market is up 200 points today, not because GM is filing bankruptcy, but rather because investors seem to understand that the event itself is not at all catastrophic. After all, Chrysler is emerging from bankruptcy shortly and actually saw sales go up after they filed. It seems that most people, investors and car buyers alike, understand that Chapter 11 is a legal corporate process first and foremost and should be an afterthought to car buyers. Still, who would have thought the market would react quite so well initially?

Two short points on GM. First, the stock is up 20% today to about 90 cents. It’s worthless, folks. Those who still grip their “efficient markets hypothesis” tightly can use this as a perfect case study against the theory.

Second, how will we be able to judge whether “New GM” is viable long term after they emerge from bankruptcy (which many say will be before summer ends)? It’s all about cost structure. Many attribute their latest woes chiefly to the weak economy and lack of credit, but they seem to have forgotten that GM was a money loser in 2006 and 2007, when credit was flowing more freely than any other time in our history.

Consider the chart below, which shows how far from profits GM has been over the last three years:

As you can see, GM needed a near-10% mark-up over cost to breakeven on their vehicles. They never hit that goal in 2006-2007, even before they started selling cars for less than they built them for in 2008. If “New GM” can get their costs down, and have them be predictable and stay low, the company might be able to make a comeback down the road. It won’t be easy, but Chapter 11 was the only way to make it even a reasonable possibility.

Full Disclosure: No position in GM, past or present.

Why Selling Your GM Stock Makes Sense, Even If Bankruptcy Is Averted

General Motors (GM) is working with bond holders to try and avert a bankruptcy filing. There are reports this morning that an agreement on a proposed debt for equity swap may have been reached. For current GM shareholders the question is pretty simple, should you sell at the current price of $1.35 per share?

Well, if GM files chapter 11 shareholders will very likely be wiped out completely (there have been a few cases when they aren’t, but it’s very unlikely). But what if the bond holders agree to certain terms and the company avoids bankruptcy? Isn’t that possibility the sole reason GM shares trade at more than $1 right now, even though the company is effectively bankrupt?

The short answer is yes, but consider another fact. In the latest proposal made to bond holders, current GM equity holders would retain 1% of the newly restructured company’s stock. In order to make the case to hold onto GM stock today, one has to argue that General Motors equity, after the restructuring, will be worth at least $80 billion (100 times the current $800 million market capitalization). How would one even begin to make that case?