Sunday, July 17, 2011

April 24, 2011


Risk/Reward Vol 63

THIS IS NOT INVESTMENT OR TAX ADVICE.  IT IS A PERSONAL REFLECTION ON INVESTING.  RELY ON NOTHING STATED HEREIN.

"The one thing I do that nobody else does is jump three or four times for one rebound."  --- Dennis Rodman

When it comes to owning and trading growth stocks (those that do not have a large dividend to act as a safety net), I feel like Dennis Rodman.  Allow me to elaborate using the most remarkable growth stock of our time---Apple, as an example.

First, look at Apple's stock performance over the past several months.  On Feb. 16, 2011, Apple closed at $362 with most analysts pegging it as a $400 to 425 stock.  Buying it at that level would not have been a bad idea.  Yet, using my (more properly William O'Neil's of IBD fame) 8% rule (never hold a stock beyond an 8% loss) would have resulted in selling that position on numerous occasions  because Apple has traded well below the $334 level (8% less than $362) on numerous occasions since, most recently last Monday.  Yet on the heals of last week's earnings report and conference call, most analysts are flashing BUY, BUY, BUY Apple.  

Why are they saying Buy?  Well, look at how incredibly Apple has performed and likely will perform in the next quarter.  Apple closed on Friday at about $350 per share.  $70 of that value is in cash ($66bn in cash on balance sheet/ 921,000,000 shares = $70 cash per share), so the value of the operation is only $281 per share.  Dividing $281 by the estimated 2011 earnings per share of $24.61 leaves a price to earnings ration (PE) of 11.5.  Dividing the PE by the anticipated growth rate of 22% leaves a Price Earnings Growth ratio (PEG ration) of 0.5%.  OMG!  Fair value is generally estimated to be at a PEG of 1 to 1.25. (The lower the PEG, the more undervalued a stock).  So, as you can see, Apple is very, very undervalued by traditional metrics at $350---even if you add the cash back.  

So why don't I own Apple now?  Reading the transcript of the earnings call held on April 20, 2011 did not allay my concerns about supply chain issues resulting from the tsunami that I discussed in Risk/Reward vol. 58, March 25, 2011.   In the conference call Q&A, Apple's Tim Cook said supply was unclear for Q4 and that he would address it again in July.  With Apple already stretched to meet demand, a disruption in critical elements like the resin discussed in my March posting could have serious repercussions.  That said, once I get comfort on supply issues, I will jump back into Apple anywhere below $400.   (Dear Readers, please send me anything you receive on this topic.)  At that time, I will also look at other smartphone favorites like Skyworks Solutions and Arm Holdings.

Yes, the life of a growth stock devotee is not unlike that of Dennis Rodman--up and down on single stocks, in and out of the game. I am ok with the analogy.   But, if I dye my hair orange or start wearing a wedding dress---call the doctor.

Because of the recent volatility of the market and its impact on growth stocks, I remain happy with my predominately dividend paying ("widow and orphan") portfolios housed in Baskerville Funds I-V.  I added the common of Commonwealth REIT and the preferred ofCincinnati Bell this week.  Speaking of "widow and orphan" stock, the Financial Times predicted more mergers and acquisitions in US utilities for the future.  Citing a report from the International Energy Agency which calculated that the US power generation industry would need to spend $1.4 trillion in upgrades and new facilities by 2035, the FT predicted that the current state of the industry (250 independent utilities with a total market cap of only $500bn) could not raise the necessary capital and could only do so after significant consolidation.  If true, we are in for a host of merger and acquisition activity which usually spells higher stock prices and profits for stockholders.

Lastly, keep your eye on labor unrest in China. Inflation is wreaking havoc on the working class there.  This is not good news for commerce.  Read about the truckers' strike in Shanghai last week.

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