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November 26, 2007
No Pain, No Gain
"It's always darkest...before it turns pitch black." - Peter Lynch
Thanksgiving was a nice diversion from the battle we've experienced in the stock market in 2007. For those of us in the investment business, this year's Turkey day is in some ways reminiscent to the first Thanksgiving that took place in Plymouth in 1621. It was there where Governor Bradford and the other 52 remaining Pilgrims gave thanks for the full harvest with the Wampanoag Indians despite losing 47 other pilgrims since landing at Plymouth Rock and losing half of the crew of the Mayflower.
Despite the arrows we've taken recently, I think we are definitely in a bull market for growth companies. While since October 31st the proxy for global technology, NASDAQ 100, is nearly 10% off - or an official correction - it's up nearly 40% since July 21st, 2007. The ThinkGrowth Index is off 8.6% since that time but it is up nearly 30% in the past 16 months. Contrast with the S&P 500 advancing 15.8% and the Russell 2000 up 12%. The S&P 500 is up just 1.6% for the year and the Russell 2000 is off 4.1%.
I had planned to spend Thursday and Friday catching up on reading and watching football. When I got to Starbucks (NASDAQ: SBUX, $23.07, Buy - Price Target: $30) on Thanksgiving morning, they were already out of The New York Times and when I got to the office on Friday morning, someone had already stolen my paper.
Consequently, instead of having to read the horrors and perils of the world such as the unwinding of Pakistan, greenhouse gases destroying our planet and our financial system imploding, I was able to think for myself what's really going on in the world.
Things that are going on which you won't see in "all the news fit to print" include:
1) A 4.01% 10-year note versus an earnings yield for the S&P 500 of 6.21%, suggesting stocks are 50% undervalued versus bonds.
2) While there is a slowing economy and the S&P 500 growth was negative 1% for the third quarter - the worst since 2002, the ThinkGrowth Index - made up of the 300 fastest growing companies - had a median EPS growth of 29.9% for the third quarter.
3) The war in Iraq is going better, and like Lincoln who had challenges finding the right leader of the military during the civil war - but ultimately found Ulysses S. Grant - President Bush has found his General with David Patraeus.
4) Contrary to what gold bugs are saying, I think inflation is dead. Commodity prices soared to catch up with the impact of global capitalism that is spreading throughout the world but seem to have caught up - aluminum and copper prices have plummeted.
5) Everybody is so bearish that it's bullish. The exceptions to the bears are the corporate insiders who are buying their own stock aggressively.
"Zigging" while others "zag" is an important strategy to make real money in the market. The megatrend or "megazag" that we see in today's stock market is the unbelievably short-term mindset of investors. It used to be normal for the time horizon for investors opportunity to be 3 to 5 years.
With a 2% fee and a 20% carry-on performance coupled with barriers to entry similar to that of a lemonade stand, there are over 15,000 hedge funds (more than 3x the number of U.S. public stocks!) running $1.4 trillion of assets - time horizons are as long as 3 to 5 days and as short as 3 to 5 minutes. Accordingly, the incentives in the performance game are to be right on the near-term perception - reality be damned.
The "zig" opportunity is to be looking for opportunities today where reasonable analysis concludes a company should be valued at 3x to 5x where the stock is today in 3 to 5 years. Before you say, go back to Lalaland - here's the math:
A company that grows its EPS at 35% for 5 years, selling at a constant P/E, will go up 4.5x - a slight multiple expansion and you have a 5 bagger in 5 years. If you find a 35% grower whose P/E doubles during that 5 year period, you have nearly a 10 bagger.
Instructive to us to see what areas are most likely to have the highest growth over the next 5 to 7 years is to look at the areas where the Venture Capitalists are investing in as their time horizon is much longer.
For the third quarter, according to PriceWaterhouse Coopers' MoneyTree, Software received 16% of all VC funding in 187 companies, Biotechnology was a close second at 15% with 99 companies funded, followed by GreenTechnology at 13%.
Back to "zagging", investors are zoomed in on "Black Friday" to provide a clue to holiday sales and the health of the consumer. Named "Black Friday," because it's the day when most retailers go from losing money for the year to making money - expectations this year seem contained. Early results are that Microsoft's Zune (NASDAQ: MSFT, $34.11 - Not Rated) is doing well, Apple's stores (NASDAQ: AAPL, $171.54, Buy - Price Target: $227) are packed and the Wii will continue to be hot for wee folk and big wee folks. Online growth appears set to continue to surge up a predicted 20%.
Buy growth!
Posted by Michael T. Moe at 09:38 AM | Comments (0)
November 19, 2007
Follow the Leaders
Our philosophy has always been to identify best in class and avoid the "me toos."
The recent market turmoil has been rough on stocks of all sorts but especially on the leaders. In other words, the companies that in our view have the strongest fundamentals and have had the best performance have dropped the most in recent weeks. For example, Baidu.com (NASDAQ: BIDU - Not Rated) which has had EPS growth year-over-year of 95% in the third quarter and is up 179.5% year-to-date, has dropped 17.6% since October 31st. Apple's (NASDAQ: AAPL, Buy - Price Target: $227) EPS is up 63% year-over-year in the third quarter and stock is up 96.1% year-to-date; in November, it has fallen 12.4%. Crocs (NASDAQ: CROX, Buy - Price Target: $72) EPS growth year-over-year for third quarter is 144%, 2007 performance is up 163.6%, and for November, it has fallen 43.4%. This contrasts with the NASDAQ 100, off 8.5%, the ThinkGrowth Index, off 8.6% and the S&P 500, down 5.9% for this month.
Chipotle Mexican Grill (NYSE: CMG - Not Rated), Synchronoss Technologies (NASDAQ: SNCR, Buy - Price Target $55), GigaMedia (NASDAQ: GIGM, Buy - Price Target: $25), Blue Coat Systems (NASDAQ: BCSI, Buy - Price Target: $50), Research In Motion (NASDAQ: RIMM, Buy - Price Target: $165), Google (NASDAQ: GOOG, Buy - Price Target: $800);
Clearly what has happened is that investors have gone from looking ahead and the future potential to looking behind. While attractive on a future earnings power, in the rear view mirror these companies look like there is a lot of air between here and the ground. Look out below!
In times of turmoil, I always like to go back to the fundamentals, which is finding the best growth companies as determined by the 4 Ps - People, Product, Potential and Predictability: http://www.bnet.com/2422-13724_23-170540.html
For today's back-to-the-basic ThinkThoughts I want to focus on the first P - People.
I believe that more than 50% of the secret to success in investing in tomorrow's big market winners is evaluating the people running a company. There is no shortage of interesting ideas, but it's always the people that make the difference. In business, sports or life, winners will find a way and my goal is to find that team and stick with it.
Often it's the vision and passion of an entrepreneur that ignites the business opportunity. Sam Walton of Wal-Mart (NYSE: WMT, $46.34, Accumulate - Price Target: $50) had a vision of bringing value and convenience to rural America. Bill Gates had a dream of making computers easier to use. Howard Schultz's vision was to bring the experience of the Italian coffee bar to America, and Irwin Jacobs's was untethered communication everywhere.
In sports, it's easy to see the effect of an individual. My friend Michael Milken - who funded a number of important nascent businesses that became large such as MCI and Turner Broadcasting - uses the example of Michael Jordan and his impact on the Chicago Bulls when he joined as a rookie in 1984. At the time, Chicago had the worst record in the NBA. That's why they had the opportunity to draft Michael Jordan. Not coincidentally, the Bulls had the worst attendance in the NBA in the year prior to Air Jordan joining the team. The basic economics for the Bulls were they had an average attendance of 225,000 per game with an average ticket price of $15 - giving Bulls, Inc. approximately $3.9 million in gate revenue for the year.
Five years later, the Bulls were sold out with a total attendance for the year of 737,000 at an average ticket price of $30. Bulls, Inc. ticket revenue was $23 million, a difference of $20 million dollars! This doesn't even factor in the multiplier effect of fair-weather fans that a winning team has. Clearly, one person made a huge difference.
Cute sport story, but how does it apply to the business world?
Source: Michael Milken
When Bill Campbell joined Intuit (NASDAQ: INTU, $30.27, Accumulate - Price Target: $33) as CEO in 1994, its revenues were $200 million--in 2000 when he became chairman, it had $2 billion. Similarly, when Mickey Drexler joined the GAP (NYSE: GAS, $20.09 - Not Rated) GAP's revenues were less than $1 billion--in 2002, when he retired, it had nearly $14 billion. When Bill McGuire joined UnitedHealth Group (NYSE: UNH, $53.42 - Not Rated) in 1989 it had revenues of just over $400 million, now it has $44 billion. Finally, when Jack Welch became CEO of General Electric (NYSE: GE, $38.65 - Not Rated) in 1981 it had revenues of $26 billion. When he left in 2001, it had revenues of $126 billion - that's a $100 billion increase in revenues! This makes it obvious that key players can have a dramatic impact, even within mediocre teams.
The goal, however, is to find a great leader at the head of a great team. After all, I've never heard an investor say, "They were bullish on the long-term outlook for a company despite the mediocre management team" (although Warren Buffett has remarked, "When a management team with a reputation for brilliance meets a business with a reputation for poor economics, it's often the business's reputation that remains intact").
Obviously, nobody ever wants to invest in average people, but how can you tell?
Unfortunately, it's not simple. It requires a lot of leg work. Many of these companies don't have long histories, but the people all do.
There are a number of questions a potential investor must ask in order to properly evaluate a company's people. What's their prior work experience? What's their reputation within the industry? What have management and employee turnover been? What's the track record for developing and promoting talent? Is there passion to build a significant lasting company or to build it up and flip it? How much stock does management own? Do they do what they say they are going to do? Are they honest and forthright? Do they underpromise and overdeliver? Is there a proper balance between short-term expectations and building long-term value? Are they building a culture where everybody shares vision and believe they're on a mission? Do they degrade their competition? Are they systematic and strategic in building their business? Is there a process and history of hiring the best people? Are they not egocentric, but team focused? Is the management concerned about the best interest of the shareholders?
Notice that I didn't list where management went to school as a key criterion. Often Wall Street is enamored with Ivy League degrees or the equivalent. While academic background can be relevant - and certainly Yale, Princeton, and Stanford have their fair share of business success stories - it's definitely not a prerequisite. Sam Walton went to the University of Missouri; Howard Schultz, Northern Michigan; Warren Buffett, the University of Nebraska; Don Fisher, University of California; and some of the most notable, such as Bill Gates, Larry Ellison, and Michael Dell, didn't even finish college.
Ultimately, it's a lot of little things that will add up to one big thing when we analyze whether management is world-class. Often, this is indeterminable at first, but over time, could be a few quarters (could be a few quarters, could be years) evaluating how management executes against its promises and opportunities is the key to finding the "megawinners."
We remain bullish on growth equities and we will use the recent decline and the top companies as a buy opportunity.
Posted by Michael T. Moe at 06:13 PM | Comments (0)
November 12, 2007
That 70s Show
During the 1950s and 1960s, a beast known as the conglomerate was born - conventional brilliance being was bigger was better. A conglomerate made up of a portfolio of vastly different businesses was thought to be more attractive because it could balance out the business cycle by trading in a niche array of goods and services.
Conglomerates with names like Gulf + Western, ITT (NYSE: ITT, $63.11 - Not Rated), Textron (NYSE: TXT, $66.76 - Not Rated), Teledyne (NYSE: TDY, $52.47 - Not Rated), Raytheon and Litton were the superstars of the day. As the esteemed former chairman of Citibank Walter Wriston said (somewhat ironically): "Investors come to overvalue growth by acquisition. That was because of the idea that a good manager could make two plus two equal five."
ITT which began its corporate life as the Puerto Rico Telephone Company, at its height it owned over 300 businesses ranging from Sheraton Hotels to Wonder Bread, to Avis Rent-A-Car (NYSE: CAR, $17.75 - Not Rated), to technical training schools, to the Hartford Insurance Company. It all made perfect sense (to a mad man perhaps) in that an ITT hotel customer through Sheraton would undoubtedly need to eat, that Wonder Bread is the staple of most travelers diets, and everybody needs insurance, particularly travelers and bread eaters. So you could see the limitless cross selling opportunities.
An unsettling environment in the 1970s with rising oil prices, an unpopular war, and a Republican administration that lost its authority contributed to the stalling and ultimate unwinding of the conglomerate ERA. "Diversification" became "diworsification" and focus became the business mantra of the new day.
Mark Twain's saying "history doesn't repeat itself but it rhymes" is especially true with today's environment.
Two separate but highly related events took place in New York City early in the week. First, with Chuck Prince's exit from the helm of Citigroup (NYSE: C, $33.10 - Not Rated), one of the most visible reincarnations of the modern conglomerate unofficially came to its end. Sandy Weill's vision of the "Financial Services Supermarket" looks more like Piggly Wiggly than Whole Foods (NASDAQ: WFMI, $43.38, Accumulate - Price Target: $56). Having every financial menu item under the sun to sell your customer, from CDs to auto insurance, to IPOs, maybe wasn't as brilliant as all the wise guys originally thought. Remember when all the smart guys said that Goldman Sachs (NYSE: GS, $211.33 - Not Rated) needed to merge with a big commercial bank or it was going to be left in the dust otherwise?
Almost simultaneously a few blocks across midtown, Barry Diller was announcing his plan to break up his $9 billion media and Internet empire into five separate businesses. Seems that investors were having trouble seeing how dating services where you could buy a seat at a concert through Ticketmaster.com, or find a mortgage through LendingTree if the date worked had a lot of synergy; "diworsification" for sure.
Meanwhile, one of those Citi umbrellas would have come in handy with the unwanted thunderstorms in the stock market. More credit worries, oil prices near $100, and weak retail numbers, all contributed to a horrible market this week.
For the year, it's been a case where the old first would be last (the Russell 2000) and the last would be the first (the NASDAQ 100). Given the upside-down nature of the past week, fittingly, the Russell 2000 was the best index, down "only" 3.2% but off 2% for the year. The worst index we track was the NASDAQ 100, off a scary 8.1% for the week but still up 15% for the year.
It's tough to have a drop in stocks like we had this week, and to be smart and confident. We feel doubly foolish given the fact that anybody who reads the Wall Street Journal or the New York Times knows what "dire circumstances" we are in. The reasons why we have some comfort is that we believe strongly in the truism "if it's in the papers, it's in the price," and the psychological fundamentals of "being fearful when others are greedy, and being greedy when others are fearful." Today, investors are in fear and panic mode, and stocks are oversold, in our view.
Moreover, some of the ongoing chorus that the bears are singing is how the weak dollar is a disaster for our economy and our stock market. It strikes us as a logical that the Chinese economy has such an advantage against the rest of the world because the Yuan is too low; also, we think one of the reasons that the U.S. economy is on its way to zero is because of the low and falling dollar. It seems to us that a cheap dollar (like a cheap Yuan to the Chinese economy) is a boon to U.S. companies that are selling goods to 95% of the world's population that lives outside of the U.S. and this logic would also apply to U.S. stocks. Accordingly, we remain optimistic, specifically for growth stocks. Reasons for this include that stocks are undervalued by 55%, and in a slowing growth economy, companies with strong organic growth will get outsized investors' attention.
Fundamentals remain strong for the most dynamic growth companies. Everybody is bearish, which is bullish.
Posted by Michael T. Moe at 05:47 PM | Comments (0)
November 05, 2007
Quake!!!
So I probably had it coming after waxing poetically on the virtues of California living - last week that we had a 5.6 earthquake Tuesday evening which was the strongest earthquake we've experienced since the Loma Prieta Earthquake of 1989 which resulted in 62 deaths and $6 billion of damages.
Unfortunately, it wasn't just the ground that was shaking last week. Stocks, quaking from more turmoil coming out of the financial institutions woes gyrated wildly throughout the week. Oil prices - which start from under the ground but get impacted by what's going on above the ground - nearly hit $100 intra-week. Google shares crossed $700 and Crocs croaked despite what we believe were great numbers. The Fed cut the discount rate by 25 basis points but warned of inflation worries and then injected $41 billion to calm markets on Thursday.
When we were able to survey the damage following all the seismic activity, what we found was it looked a lot like it's been looking lately. The Old Guards - proxied by the S&P 500 were down 1.7% for the week and the New Guards (which is the Old Tech Guard) - proxied by the NASDAQ 100 are up 0.9%. Additionally, the NASDAQ advanced 0.2% for the week.
Now for the year, the NASDAQ 100 is up 25.1%, the ThinkGrowth Index is up 22.7% versus the S&P 500 up just 6.5% and the Russell 2000 advancing 1.2%.
We've been shouting as loud as we can, that we have entered a BULL market for Growth companies and Technology companies and we believe the proof is in the pudding. While the indices speak for themselves, looking at the top 10 performers from both the ThinkResearch Universe and the ThinkGrowth Index, we have had some very good performers.
Notably, number one ThinkResearch performer Synchronoss is up 297%, Crocs - which reported 122% revenue growth and 144% EPS growth this week and was down 36% that day! - is still up 277% for the year. Omniture, which in our opinion, has VERY long legs, is up 276%. From the ThinkGrowth Index, Onyx Pharmaceuticals is up 345%, Baidu.com has advanced 243%, and SunPower is up 237%.
The reasons that we have seen such strong performance for growth stocks in general and in particular names that we just highlighted include, in our view:
- Overtime - EPS growth drives stock prices and the earnings growth for the ThinkEquity Research Universe is 24%, for the ThinkGrowth Index 30% and for most of these top performers, has been substantially higher than these figures.
- In a world which has the S&P 500 having negative growth for the quarter for the first time since 2002, companies that are experiencing outsized growth are that much more attractive.
- With an earnings yield for S&P 500 stocks at 6.2% versus 4.3% for the 10-year note, overall equities are 44% undervalued and growth equities even more so.
- We have entered a growth cycle, which if history is a guide, won't be measured in months but in years.
Looking at the growth, with most companies having reported third-quarter results, EPS for the S&P 500 is expected at a negative 0.1% versus the TGI which has reported an average of 59.1% and the ThinkResearch Universe which is at 35.3%.
While we expect volatility to remain intense, we remain intense on our focus for the fastest-growing companies that we believe will lead to superior performance.
Posted by Michael T. Moe at 02:15 PM | Comments (0)