Thursday, March 31, 2011

The Song Remains The Same

Today is the end of the quarter which means earnings season will soon be upon us and set the tone for stocks once guidance is provided. For the past few months I've primarily been reviewing books and analyzing stocks and want to update you on The Ithaca Experiment Portfolio. If you've been reading this blog, you are well aware I have been out of the market since October of 2008 and have been in leveraged and short ETFs since the Summer of 2009. This self inflicted wound has made me miss a significant ride in the market. To say I don't regret my investing decisions would be sour grapes. However, what's past is past, and, I didn't give up the ghost in regards to my portfolio allocations despite the nice rebound the market has experienced of late.

In examining the S&P 500, you can see that it closed at 1319 on 2/7/11 and was at the same level when the bell rang yesterday. In essence, my short ETFs have treaded water for the last 7 weeks which has kept my game going. I realize my thoughts on market direction are not in vogue at this time. I take the nonconsensus view that not only are we in store for a double dip of the lows in March 2009, but, I believe the market will actually go lower. This is why I'm still short with The Ithaca Experiment portfolio and in my personal accounts am hording cash. I really believe that there will be a much better time to back up the truck when shopping for securities somewhere down the line. The sooner the better, too.

To use that old Wall Street cliché - "the market climbs a wall of worry" - is warranted in describing the market's unbelievable rise the past two years. Nothing seems to be able to derail it. One thing that helps my cause is that I've bought some time the last few months with the market going nowhere. The third year of a bull market tends to be choppy and less vigorous than the first two years of the run. I'm not going to tell you what will cause the markets to reverse course because I've been down this road before with no such luck. What I will say is that I still believe that there are accentuating circumstances that may help me out this year.

Sovereign debt, especially in Europe remains a concern. The same thing goes for local, state and federal debt in the United States. We can't keep printing money forever without some severe ramifications. One third of all mortgages in the United States are underwater. This will deflate consumer spending. Unrest in the Middle East will put pressure to the upside on oil prices which will drag down the economy. There is also the tragedy in Japan where the Geiger counters are at full tilt and supply chains have become disrupted, especially in the semi-conductor industry. These are issues I think about and that I believe will exacerbate the slowdown.

Right now my strategy will remain the same and stay the course. My biggest fear is getting cold feet and selling my short positions right before we get an about face and experience a severe correction. As far as this blog is concerned, I will continue analyzing stocks that are candidates for inclusion in my portfolio once valuations are much more reasonable. Reviewing investment books will also be in the grand scheme of things. Once every so often, I will also cover pertinent financial topics like high frequency trading or dark pools. Take the hands off the clock, we may be here for awhile.

Tuesday, March 29, 2011

Netflix: From The Sideshow To The Big Top

Netflix (NFLX) is a compelling story, not only because the stock price has appreciated over 200% in the last year, but because its technology is extremely relevant in today's society and will continue to be so for the foreseeable future. This is one of the cocktail party stocks of the past 12 months and rightfully so. Just last week the stock was trading at $210/share, then Credit Suisse placed a $280 price target on it and the stock mushroomed to $240 in only five trading days.

Unless you live in a hi-tech hub like the Silicon Valley or are an avid investor, the average person probably associates Netflix with the 20th century business model of mail order subscriptions. This is no longer the case. A few years ago the company started streaming their video service over the Internet and business is booming. Warren Buffett says to wait for a fat pitch when selecting a stock and Netflix appears to be way out of my wheelhouse with a P/E Ratio of 55 based on average 2011 earnings on Yahoo Finance. However, I obtained a copy of last week's Credit Suisse analyst report and want to take a close look at it in case I am missing something here.

At first glance, it's easy to see that Credit Suisse set the bar very high when assessing the value of Netflix going forward. Their earnings per share estimate for 2011 is $5.16 and boldly moves to $8.35 for 2012. Yahoo Finance pegs the EPS average at $4.39 for this year and $6.29 for 2012 based on the 31 analysts that cover the stock. That's quite a difference in outlook. In fact, out of those 31 analysts, only 11 have a buy or strong buy rating on Netflix. The remainder breaks down as 13 hold, 5 underperform and 2 sell.

I've got to tell you flat out that this stock is too hot to handle and is probably a crowded trade - at least for this week. Only professional traders should own it. Credit Suisse may very well be right that Netflix can move higher because it is one of the most radioactive stocks on the market. It currently ranks 7th on the Investor's Business Daily top 50 stocks for the week and with the market gaining momentum, it can probably probe the upside because stocks on the IBD 50 are conducive to higher prices in the short term. That said, I really believe that the analysts from Credit Suisse that wrote the report did a disservice to their investors by not doing a thorough job. They wrote a puff piece. I don't know what kind of skull session they had when coming up with their numbers, but in my opinion, it was a pretty vacant decision.

The Credit Suisse analysts paint rosy scenarios about international expansion when concocting their earnings and revenue extrapolations. Much of this stems from the fact that Netflix introduced their streaming service to Canada in 2010 and has had a very successful campaign there. Subscriptions are projected to grow 20% a year through 2016 in The Great White North, however, this is a very small client base. The analysts contend that if, and the operative word is if, Netflix expands into one to two international markets per year for the next 5 years, then they will meet their numbers.

I can understand that the research department at Credit Suisse sees a bright future for Netflix because they compete, and I emphasize that word compete, in an area that will no doubt be in hyper-growth mode for the next few years. However, the Credit Suisse analysts were extremely cavalier when addressing the competition. They didn't seem too worried about it, like Netflix will be like Rommel going through North Africa or Sherman marching to Atlanta.

When Netflix chairman and founder Reed Hastings was asked in the last conference call: "Do you expect Google (GOOG), Amazon (AMZN) and/or Apple (AAPL) to be a more formidable competitor in 2011?", he replied: "Definitely, there's a lot of firms, including the ones you mentioned that could be a more direct competitor with us.". Besides Facebook and, there are also large predators on the prowl: "...cable providers like Time Warner (TWC) and Comcast (CMCSK); direct broadcast satellite providers, DIRECTV (DTV) and Echostar (SATS); and telecommunications providers such as AT&T (T) and Verizon (VZ).". That was courtesy of the Netflix 10-K. The hunter becomes the hunted.

One example of how the Credit Suisse analysts glossed over the hurdles Netflix will have to overcome goes back to international expansion, specifically in Europe. Their overzealous projections of potential subscriber growth overseas includes the countries Germany, The United Kingdom and The Netherlands. The big problem here is that Amazon is already established in those countries with its subsidiary LOVEFiLM that they purchased earlier this year. Granted, they only have 1.5 million subscribers, but they have already established a beachhead there and with Amazon's deep pockets, can expand to other countries as well. Credit Suisse doesn't expect Netflix will enter the European market until 2013 at the earliest.

I believe in Reed Hastings and I tip my hat to him. He's created an incredible company with a very bright future ahead of it. Subscriptions are growing at a breakneck pace. However, a company and its stock are two entirely different animals. With a price at roughly $240 and it's 5 year CAGR of 30%, you get a PEG Ratio of 1.8 when you use a P/E Ratio of 55. Not too shabby if you are a momentum investor, but like I mentioned earlier, it's way out of my strike zone. I prefer PEG ratios at one, and even then, it gets a little dicey. The lower the better, especially if they are experiencing growth and its sector is out of favor. A good example are healthcare stocks right now.

Another thing to contemplate when deciding if you want to make an investment in Netflix is considering exactly what kind of a company they are. They are a facilitatior of digital media. A distribution company. Not a hi-tech firm, although they use state-of-the-art technology to dispense their products. They have no significant moat around their business in regard to patents. In fact, their rival Amazon dispenses most of their content with their cloud based server farms.

Credit Suisse posted a disclaimer on the first page of their research report which read: "Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.". That I will do and you should too. Don't believe the hype.

Saturday, March 26, 2011


John Mauldin and Jonathan Tepper recently teamed up to write Endgame: The End Of The Debt Supercycle And How It Changes Everything with John Wiley & Sons. The subtitle basically gives you the gist of the book, but that would give it short shrift for such a well researched and documented piece of work. They say right at the beginning of the book that: "When we mention endgame, you'll immediately want to know what is ending. What we think is ending for a significant number of countries in the 'developed' world is the debt supercycle...Essentially, the debt supercycle is the decades-long growth of debt from small and manageable levels, to a point where bond markets rebel and the debt has to be restructured or reduced. A program of austerity must be undertaken to bring the debt back to acceptable levels.".

This echos the sentiment of the Republican Party, its sub-set the Tea Party, and, some Democrats, but, I got the impression that the authors were agnostic in their political leanings and came to their conclusions by objectively interpreting the data. As stated: "Common sense tells you that your debt cannot grow faster than your income forever, and at a certain stage, the huge pile of debt becomes unsustainable. All responsible parents teach there children not to let their debt grow faster than their income. It is only the Fed and Congress that are too foolish to get it.".

They pound this theme throughout Endgame and the language they use ranges from academic speak to something a layman could understand: "If you had a neighbor who was always running up credit card bills and who constantly borrowed money from neighbors to help pay the credit card bills, would you conclude your neighbor was a high bankruptcy risk?".

Mauldin and Tepper appear to be greatly influenced by This Time Is Different written by Carmen Reinhart and Kenneth Rogoff, and, in fact, devote a whole chapter to not only deciphering the book, but interviewing the authors, too. I found this section distracting because I'd already read the book and they reprinted long excerpts from it. It couldn't hold my interest. However, if you are unfamiliar with the work, it would be a great place to start examining financial folly going back eight centuries.

In that chapter they quote Reinhart and Rogoff and I will too: "Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! - confidence collapses, leaders disappear, and a crisis hits." The authors of Endgame follow that up with some commentary of their own: "It is the nature of human beings to assume that the current trend will work out, that things can't really be that bad. The trend is your friend until it ends.".

They believe that the current trend is going to end, at least where massive government and private debts are concerned: "...for the most part, debts have not been extinguished, merely transferred. Debt is moving from consumer household balance sheets to the government. While the debt supercycle was about the unsustainable rise of debt in the private sector, endgame is the crisis we will see in the public sector debt.". How bad will the crisis get? They don't give a definitive answer, just some options, and, not all of them bleak. For instance, they don't feel the United States will experience hyperinflation nor do they surmise that the Tea Party will take over and take us back to the gold standard. However, the unwinding of all of the debt on a global basis will take time and the process will hurt.

Both Mauldin and Tepper are investment advisers and have plenty of experience in the field, so you're not getting an ivory tower analysis of the current economic landscape from the Academic Industrial Complex. They're pretty much straight shooters and I enjoyed the book. They give no timetable on when this endgame will occur but do say that higher volatility, lower trend growth and elevated levels of unemployment will be the norm. There are many books that have been published over the past couple of years that cover the same themes that are in Endgame. The authors just put a different spin on the data, and, it's the freshest one hot off the printing press, so you may find new material in here if you are well versed in the subject.

Wednesday, March 23, 2011

United Therapeutics: At First I Look At The Purse

Nothing gets an investor wide-eyed like the prospect of jump starting their portfolio with a hot biotechnology stock that's reaching a boiling point. This is especially true if the jury is still out in regards to launching a new pharmaceutical in Phase III trials. Unfortunately, most promising drugs don't reach the light of day. As stated in a recent TheStreet Ratings Report: "An average drug takes about 10 to 15 years from pre-clinical development to market approval. According to the FDA, for every 20 drugs that enter the clinical testing stage, only a few pass trial and gain approval.".

Still, investors with a heavy gambling bent place significant bets on biotechnology companies that have never made a dime and have no products on the market. Why? I really don't know. It's a crap shoot. I prefer the companies to be profitable and have something for sale if I'm going to buy shares or keep an eye on it.

One biotechnology company that fits my criteria for inclusion on my watch list is United Therapeutics (UTHR). It's been profitable since 2004 with plenty of products on the market and in the pipeline - some almost ready to hatch. United Therapeutics has had a nice run since the market crash in late 2008, early 2009, rising from $24/share to its current price of $65, but, you may not be late to the party if you haven't already invested in it.

If you aren't acquainted with United Therapeutics, they are a pure play in PAH (pulmonary arterial hypertension or more commonly known as persistent high blood pressure). In a recent Credit Suisse report they explain that the global PAH population is estimated to be between 100,000-300,000 patients worldwide. This doesn't sound like a large number when compared to other maladies, but, in the arena in which United Therapeutics performs, there are not many treatment options available. They're king of the jungle.

When you consider that their medication is very costly with a price tag greater than $100,000 per patient, you can see why the company is now in it's 9th year of its revenues growing by over 30% a year from the preceding year as articulated by CEO Martine Rothblatt in the latest conference call. Not only has United Therapeutics grown in the past decade, but the PAH market has as well, starting at near zero in 2001 to $3 billion this past year.

Although United Therapeutics sells cardiac event monitors, for the purpose of this posting, I'm just concentrating on their product portfolio of controlled substances. Their main offering is Remodulin which can be administered intravenously or with a subcutaneous pump. Not very fun if you're the patient, but this packs the biggest punch in regards to efficacy. Second in the pecking order is Tyvaso which is is inhaled, and, lastly is Adrica which is taken orally. All the remedies mentioned above are for the treatment of PAH and all are considered to be growing at a very high rate for the next 5-6 years. What's even more exiting is what's coming down the pike in the pipeline.

United Therapeutics currently has an oral version of Remodulin that's being developed and is in two Phase III trials. Clinical data from both studies is expected to emerge in June and September of 2011. This could supercharge profitability past 2017 according to Credit Suisse. In addition, the company is branching out into other areas of medicine and has two Phase II trails under way. One is attempting to find a solution to idiopathic pulmonary fibrosis and the other trial is researching a drug for scleroderma. United Therapeutics has excellent future prospects, but as mentioned earlier, nothing is guaranteed in pharmaceutical studies. What they do have going for them is current earnings.

Based on the average estimate of the 19 analysts that cover the stock on Yahoo Finance, earnings are projected to come in at $2.82/share for 2011 and $3.47 for 2012. This gives it a 2011 P/E of 23 and going forward, a P/E ratio of 19. This is very reasonable for a stock with CAGR of 25% for the next 3-5 years. In fact, I low-balled the growth rate by using the ValueLine projections because they tend to extrapolate on the conservative side. If you would follow the mean analyst CAGR, you'd come up with 54%. It's a low PEG ratio (price/earnings/growth) no matter which metric you chose and I would think this would be a nice equity to consider if you don't have a short attention span.

One caveat to United Therapeutics is that their earnings from quarter to quarter tend to be inconsistent, so the stock can be volatile. However, as Warren Buffett is famous for saying: "I have always preferred a lumpy 15% return to a smooth 12% return.". I also noticed that during the sub-prime financial crisis, its price was cut in half, but they also had lousy earnings that year even though sales increased at a healthy clip. If we do get a pull back in the market, you may be able to buy it at a lower price. On a final note, they've just been picked up for distribution in China even though Remodulin has not been approved there. If they do get the high sign from the Chinese government, and, their Phase III trials are successful, watch out.

Monday, March 21, 2011

Small Cap Focus: Seachange International

Seachange International (SEAC) is a fallen angel from the craze a decade ago. Back in 2000, it traded as high as $76/share and, after staggering down to $5 in 2002, has basically dithered in a range of $5-$10 except for a brief run up to $20 in 2004. Many investment experts say to avoid stocks under $10 (most notably Investor's Business Daily), but I believe that some securities trading in the single digits are worth an examination. Apple was selling as low as $6 in 2003 and look where it is now. I am not suggesting an underdog like Seachange will the rise to the heights that Apple has, but may be in store for a second act, and we could see a renaissance in price.

I don't like to kick a stock when it's down, but Seachange is so unloved and down-on-its-luck that only three analysts cover it; two with favorable ratings and one a hold according to Yahoo Finance. To compound matters even worse, they just released 4th quarter and full year earnings for 2011 and Wall Street lowered the boom. The stock was down 7% to $8.65 in after hours trading immediately following the conference call. It has since bounced back twenty cents in the last two days. No great shakes. So what do I see so promising in it? Well, the future.

Seachange is the global leader in selling Video-On-Demand (VOD) hardware and software systems to large, worldwide cable and telecommunications companies like Comcast, Cablevision, Cox Communications, Virgin Media, Rogers, Viacom, ABC Disney, Clear Channel and China Central Television. If you haven't seen a retail video store like Blockbuster or Hollywood Video of late, it is because of disruptive technology like Seachange's VOD systems that made their business models obsolete. Why take a trip to the store to rent a movie when you can get it in your living room with just a click of the remote control?

Another business segment that Seachange excels in is local spot ad insertions into national broadcasts. In fact, 70% of operators use Seachange's ad insertion system, and this type of target marketing is only going to evolve as not only Big Brother collects more and more personal information about you, but as the television and Internet begin to merge. Going forward, all viewing will be on an interactive basis. It's happening already to some extent.

Not only will the company's interaction with the television increase profits in the upcoming years, but another growth driver is it's expansion into what is now being dubbed as a multi-screen offering by their customers, i.e., the personal computers, tablets and smartphones. In a 12/9/2010 conference call, president Yvette Kanouff stated: "...across every single operator they are very serious about doing multi-screen. The 90% priority is the PC as the second screen more so than mobile.".

With Seachange's new Adrenaline platform, they will be able to offer their middleware for carriers who wish to launch multiple screens such as the iPhone, iPad and Android. It's only a matter of time before these telecommunications companies and cable operators become larger by offering considerably more content for your mobile devices. If past performance and continuing business relationships are a factor, then Seachange will be a benefactor in this development.

In examining its 10-K, Seachange International sounds like a stock that is ready to make an incendiary move upwards. The only problem is, all hi-tech companies annual reports sound like their products are the next great thing with all of the colorful acronyms they employ. Let's face it, Seachange has experienced trouble executing. This is why the stock is so inexpensive and can't beat the street's expectations.

There are many reasons the stock has flatlined the last 10 years. One is a good one; that the company made many acquisitions to solidify their position as worldwide industry leader which put pressure on profits. The other is not so good in that their hardware division is in the red and puts a drag on earnings. They are attempting to combat this situation by recently releasing Axiom, software that is independent of their hardware that can be deployed to third party hardware platforms. I believe this is a step in the right direction towards increased profitability.

In its current composition, Seachange derives 65% of sales from software, 25% from hardware and the remaining 10% from media services which along with software is growing rapidly. According to a recent ValueLine report, international sales represent 45% of revenues with demand the strongest in Europe and the Middle East. Although they do business in Japan, it is not a large enough part of their business to have a huge impact on profits because of the current crisis, but I surmise may have a minute ripple effect on revenues to a small degree in the next year. I really like the fact they commit 25% of revenues to R&D. That borders on the high side for a company of any size, but is what a smaller hi-tech company wants to do when they are in innovation mode to compete against competitors with deeper pockets. Seachange's largest rival is Cisco (CSCO).

On a valuation level, Seachange looks very compelling at roughly $8.75/share. Bear in mind that because of the lack of analyst coverage, I am using ValueLine statistics to compute the numbers: price/sales is 1.1, price/book equals 1, price/cash flow comes out to 8.5 and price/earnings is a reasonable 14. That's a value stock. However, it needs to get a grip and execute before it might force a shift in investor sentiment and send the stock higher. This, coupled with the fact that the market as a whole may be under pressure in the near term taking the stock lower, makes me want to sit on the sidelines for the time being. With it's market leading position in its flagship products, this stock has more than a puncher's chance.

Saturday, March 19, 2011

Drilling Down With Informatica

Finally, after ten long years of clawing every inch of the way back, Informatica (INFA) is getting close to its all time high of $58/share during the bubble. It didn't stay at $58 very long because in one fell swoop, it collapsed to $3 just a few months later in early 2001. Last Summer you could have scooped it up for $22, but those days are over and the price has since mushroomed to close to $50.

I've been intrigued, not by the stock, but by it's sector of data mining ever since I became aware of it a couple of years ago. Data mining stocks haven't really piqued my interest that much because the main players are software industry behemoths IBM (IBM), Oracle (ORCL), Microsoft (MSFT) and SAP (SAP). The slower growing, larger companies aren't as compelling to me as their more nimble, smaller, faster growing brethren. Informatica fits that bill and recently caught my eye because it sits in the middle of the pack on the Investor's Business Daily top fifty stock picks.

As I've mentioned in earlier posts, equities that reside in the IBD 50 raise a red flag because they have a great amount of momentum behind them, and, are candidates for pull-backs. Some more severe than others. Think F5 Networks (FFIV) of late, or, going back a few years, Veriphone (PAY). I want to give Informatica more scrutiny because I think it may be in the right place for continued growth given the industry it's in, but, want to look at the other side of the equation, too.

Data mining companies basically facilitate the management of enterprise data warehousing and data integration software. Their products access and transform data from a large variety of legacy and cloud systems and deliver it to other data warehouses, transactional systems and analytic applications. According to Investor's Business Daily, they help: "...companies, governments and research institutions store, manage and understand the data they collect.".

To be more specific, I am going to paraphrase the Informatica 2010 10K and state: that during the past 20 years, companies have made large investments in process automation. The results are silos of data created by a variety of software applications such as: enterprise resource planning (ERP), customer relationship management (CRM), supply chain management (SCM) and in-house departmental operational systems. These applications have increased data fragmentation and complexity because they generate massive volumes of data in disparate software systems that were not designed to share data and interoperate with one another.

In addition to the more conventional enterprise applications, the recent onslaught of social networking and mobile computing in the workplace has increased corporate data even more. As Informatica CEO Sohaib Abbasi explains in the most recent conference call: "Relational database applications manage transactions. Social networking manages interactions. And the promise for social computing is for the enterprise to gain a competitive advantage by being proactive with current social data rather than being reactive with past relational data....The combined usage of by enterprises of social networking services such as Twitter, Facebook and blogging is doubling every year, resulting in the recent unprecedented explosion of data.".

How explosive? According to the incredibly persuasive Abbasi, Informatica's addressable market was $11 billion in 2005 and is expected to grow to $40 billion by 2013. I also saw some conflicting statistics by market researcher IDC that claims an 8.5% compounded annual growth rate for revenues in the market from 2009 to 2014. Not exactly an apples to apples comparison, but you get the drift.

No matter what industry data you wish to follow, the average analyst expectation for CAGR in the next 5 years for Informatica is 18.5% according to Yahoo Finance. With a current price of $47 and a P/E Ratio of 42, you get a PEG Ratio (price/earnings/growth) to the tune of 2.3. Not exactly nosebleed altitudes, but calls into question just how long the company can continue its impressive run, at least at the pace it has experienced the last six months.

In addition to valuation concerns, there is also the problem of competition. In a recent Standard & Poor's report evaluating Informatica, they specifically address the other players in the field, with the top 5 largest vendors captivating a 59.6% share of the market. Informatica ranks 7th, but only commands a 1.4% slice. It can be argued that this only gives them more room to grow, but it may also signal slim pickings going forward as companies like IBM, Microsoft, Oracle and SAP gain better traction with their more robust platforms. Informatica continues taking steps to broaden its offerings, but eventually, it may hit a ceiling.

If you are a momentum player, this may be a good place to park your money as Informatica has had the Midas Touch of late. I'm a believer that things return to the mean and if you apply this to their lofty P/E ratio of 42, you can probably bag this stock at a more reasonable valuation. Going back 5 years, Informatica's P/E ratio has typically been a more modest 26. Bear in mind that Informatica had a great 2010, so comparisons going forward will be more difficult. That, coupled with the fact that the market is currently under pressure, make me inclined to sit back and wait.

Monday, March 14, 2011

The Age of Deleveraging

A few months ago John Wiley & Sons released Gary Shilling's 500 page investing manifesto The Age of Deleveraging. If you aren't familiar with Shilling, he can probably be considered a heavyweight in financial circles with his impressive resumé: noted book author, Forbes Magazine columnist and respected money manager. His most recent claim to fame is being on the advisory panel of John Paulson & Company during its rise to prominence in the Hedge Fund industry when they bet against the housing market in 2006-2008. Shilling was in on the ground floor of one of the biggest financial bonanzas in history.

Unless you've been in a coma for the past 15 years, or, are new to investing, I'd skip the first 5 chapters and begin reading with chapter 6. Shilling doesn't mince words in this first section as he pontificates with evangelical zeal about the market bubbles since 1995 and the bursting of those bubbles. He goes into meticulous detail about the collapse of both the era and sub-prime crisis, to a fault in my opinion because it's all been said and done before. The mantra throughout this first part of the book is something like, "Gary Shilling made a lot of great calls in predicting the market's movements.". There was too much hubris in these chapters and quite frankly, was a bit of a turn-off. However, it didn't stop me from reading on because, if big egos were a problem, I'd have to stop watching sports, listening to music and going to the movies. Enough said.

The second part of the book is dedicated to Shilling's belief that the entire global economy is in store for a decade of slow growth and he gives ample proof to back up his argument. The author is of the school that that there is no such thing as decoupling and that the civilized world's economies are all hinged upon the success of what happens here in the United States. There are ramifications from the massive debts consumers and governments have racked up the past 30 years and here is where Shilling delivers the goods.

Shilling gives a list of nine causes of slow global growth in future years and then goes into painstaking detail about each of his points to insure there are no cross-currents in the data. Included in this list is the case for a deflationary era, unlike the majority of his contemporaries who cite inflation as the problem going forward. The author states that our path here in America looks very similar to the one Japan has embarked on for the last 20 years.

Shilling doesn't forecast a pyrotechnic environment for stocks in the coming decade: "...if I'm right that real GDP will grow about 2 percent per year for the next decade compared with 3.7 percent per year in 1982-2000, that secular bear market will continue to prowl. Stocks aren't likely to decline nonstop...But reflecting shorter, weaker economic expansions and longer, deeper recessions, bull markets are likely to be less robust than during the previous secular bull market, and bear markets will be frequent and more severe.". Later in the same chapter he goes on to say: "There is, of course, a slim, remote, inconsequential, highly improbable chance that I'm dead wrong in my forecast and, instead, the economy takes off like a scalded dog.".

The final section of The Age of Deleveraging encompasses 150 pages and Shilling gives you 12 investments to avoid, and, 12 investments to consider for the next decade. The author pulls no punches, and, like the section before (or the whole book for that matter), he goes the extra mile in backing up his thesis with plenty of statistics. It should be noted that he could have given you the abridged version of his lists and just shoehorned in some data, but he makes his points very believable with his presentations. I found it interesting that among the investments he says to avoid, he includes banks, commodities and emerging markets. On the buy side, he likes dividend paying securities, the U.S. dollar and healthcare.

He mentions throughout the book that he goes against the herd and if you've been following the market pundits of late, his investing ideas surely fit that bill. Shilling does not give any specific stock recommendations because he is not a stock picker. His approach is top-down which means he just invests in sectors or themes with ETFs or some mutual funds. He is also big on market timing and is not in the buy-and-hold camp.

I know how difficult it is to write a paragraph, let alone a 500 page book, and, I prefer to read every word an author writes to pick up the nuances in the text, but found myself skimming some parts of The Age of Deleveraging. The book was just so long and laden with statistics, it couldn't hold my interest in some instances. That's not to say it's not a good book. It is. You can get a lot out of this if you read it in small increments. If you are a bull, you may not agree with what Shilling has to say, but it might give you additional insight as to what may happen in the next decade. If you are a bear, it will give you plenty of ideas on how to make money in a contracting and volatile economy.

Wednesday, March 9, 2011

Nuance Communications: One Step Beyond

Nuance Communications (NUAN) had an agenda the past seven years. That agenda was to spearhead their push to be, by far, the leader in speech recognition technology. Nuance was successful with their goal, but not without some sacrifices. Because of the many costs incurred by making acquisitions of smaller companies to help solidify their position as market leader, they haven't been able to quite put it together in regards to profits. This year Nuance is going from the red and into the black, and, I want to take a look at it because their kind of disruptive technology puts them in the category of a sexy security. Given human nature, this could catapult them to a much higher valuation level.

To the consumer, Nuance's technology is stealthily ubiquitous. Make a telephone call to Bank of America, Citibank, Disney, FedEx, United Airlines or Wells Fargo and you are interacting with Nuance voice-enabled technology. Dictate directions to a GPS device like a TomTom or a Garmin and you are working with Nuance know how. Have a Bluetooth set-up in your automobile from the likes of Audi, BMW, Ford or Mercedes Benz and again, those voice commands you utter are successful because of Nuance. Apple, HTC, LG Electronics, Nokia, Samsung and T-Mobile smartphones and, some tablets like the iPad, can use Nuance engineering for verbal prompts and speech to text solutions.

Besides their Consumer and Enterprise divisions, Nuance has also established beach-heads in Imaging and HealthCare. In fact, the Healthcare segment constitutes 40% of their revenues, while Consumer and Enterprise comprise 26% apiece, and, Imaging is a distant 4th with 8%. ValueLine seems to feel that the Consumer and Mobile division will probably make or break the company in the next few years. I disagree. I believe the Healthcare unit will be a big boon to both the top and bottom lines and I'm going to explore this division in greater depth because it will be boosted by the HITECH Act and could sway investor psychology.

I've written about the HITECH Act in other postings and in order to not be redundant, will give you the condensed version. The HITECH Act is part of the US Government Stimulus Plan where almost $30 billion has been slotted to reimburse physicians and hospitals for adopting electronic health records (EHR) in their practices. With a current minuscule market penetration of 10%, the US Government's goal is to equip 90% of doctors with electronic health records by 2019. This digital divide with physicians is not from a lack of technical expertise, but from a belief that electronic health records, "slow them down and don't achieve a measurable financial impact.", according to a recent Wall Street Journal article. That's where Nuance comes in.

Nuance's speech recognition products dovetail with most, if not all, of the main players in the EHR space. Companies such as Cerner, Allscripts Healthcare and Epic utilize Nuance technologies that are currently in use at The Cleveland Clinic, Department of Veterans Affairs, The Mayo Clinic and the US Army. In addition, Nuance and Athenahealth have recently partnered with a new platform to enable speech to text capabilities in the cloud computing space.

According to a 3/1/2011 article on PhysiciansMoneyDigest.Com, the Fallon Clinic in Worchester, MA, phased in Nuance's speech recognition products to interface with their EHR's and saved more than $7,000 annually per physician in transcription costs. With HMO's and medical insurance companies' iron grip on the Healthcare Industry, I would not be surprised if they insist of the adoption of voice enabling technologies to reduce costs and speed up patient processing. Adapting to Nuance's products will eventually be inevitable, like going from the telegraph to the telephone. Those who do not assimilate will be fighting the last war and be left behind.

With such a commanding lead in its industry, what could short-circuit Nuance's rise to prominence and make it hit the wall? The war chests of two of its rivals, Microsoft and Google. Nuance may have a fight on its hands in regards to a turf battle, but I believe that because of its dominating position in the space, it would most likely be an acquisition target with the deep pockets of its two lagging, but, larger competitors who covet their technology. After all, we're talking about going forward, not going back, and that's what speech recognition is all about.

The analyst circus in tow seems to be enamored with Nuance even though its shares have gained 300% in the last two years. Out of the 19 firms that cover the stock, 15 have a buy or strong buy recommendation on Nuance according to Yahoo Finance. It's a difficult stock to evaluate because of a lack of an earnings history, which always makes my knees buckle a bit, but, there is a work around for that. That alternative solution is a free cash flow analysis as opposed to your more traditional P/E, PEG or Price/Sales Ratios.

From the research that I've done on security metrics, a good rule of thumb when looking for an inexpensive equity based on a Price/Cash Flow Ratio is to find one with a P/CF Ratio under 10. According to ValueLine, the Cash Flow/Share on Nuance is $.80 and with its shares trading at roughly $18, you get a P/CF ratio of 22.5. That's way out of my league. I'm not implying I would wait for the P/CF ratio to get down to 10, but at more than double that, it looks very expensive to me despite the great story behind it.

I know I'm on a tightrope with the message that I believe we are due for a serious market correction which is why I'm hesitant to put money to work at this juncture. I am certainly keeping an eye on stocks like Nuance and including them in my watch list for investment opportunities under much more favorable conditions. If you are in the Bull's camp, then by all means knock yourself out and maybe make a wager on something with a very bright future like Nuance. Personally, I'm going to sit this one out and wait.

Saturday, March 5, 2011

Athenahealth: Not Going Away Quietly

Athenahealth (ATHN) took a major hit in 2010 when the company got rocked by an accounting scandal. Shares dropped from $47 to $21 in the matter of months because it was alleged they issued misrepresentations to the market that artificially inflated the equity value back in late 2009 and early 2010. Since those dark days the stock has clawed its way back to the $45 range because of its position as an up and comer in two market segments that are currently on fire. Those two particulars are cloud computing and electronic healthcare information systems, both poised to grow exponentially in the next five years.

With a 2011 P/E Ratio of 58 and a PEG Ratio (price/earnings/growth) of 1.8, Athenahealth is a bit out of my comfort zone (based on mean Yahoo Finance analyst estimates). Apparently a majority of the analysts don't have that much of a confidence level in the stock either because out of the 24 analysts that cover it, only 7 have a buy or strong buy rating while the majority of the remainder have issued a hold on it, and, three give it an underperform or sell. Athenahealth isn't bulletproof, no stock is, but I am wondering why so many analysts have a hold rating on it with a PEG Ratio of only 1.8 which isn't too out of the ordinary with a company experiencing such a high growth rate of 33%. A closer look is warranted.

Athenahealth is one of the few pure plays in the cloud computing space residing within the exploding electronic healthcare information systems industry. Its flagship offering is athenaCollector that automates billing functions for physicians and ensures they get paid faster and at a higher rate. A newer product, athenaClinicals, automates and manages medical record functions, and this product is where the real growth is. In a recent ratings report, they state: "Only 10% of US hospitals have implemented HIT (healthcare IT) while 16% of primary care physicians have adopted EHRs (electronic health records)....The EHR market, estimated to be around $1.2 billion, is expected to surge 400% in the next 8 years.".

The catalyst for this billowing growth isn't unbridled demand from the free market economy, but government intervention from the American Recovery and Reinvestment Act of 2009, aka, the stimulus plan. Part of the stimulus plan is the HITECH (Health Information for Economic and Clinical Health) Act where nearly $30 billion has been slotted for the increase in use of electronic health records by hospitals and physicians. The goal of the HITECH Act, as reported by ALN Medical Management, is to: "...rapidly increase EHR adoption to 90 percent for physicians and 70 percent for hospitals by 2019.". Under the plan, each physician would receive up to $64,000 in the form of government incentive payments for those who comply with the HITECH Act. Reimbursement starts in January of 2011.

In Athenahealth's 2/18/11 conference call, CEO Jonathan Bush comments: "The reason that the HITECH Act hurt us, if it hurt us at all, would be the fact that lots of people made big decisions about their practice without first learning about Athenahealth.". I don't like to stereotype people or professions, but physicians tend to be smart, well informed and networked for the most part. I would assume that a majority of them would be familiar with the significant players in the EHR space from either following the stock market, recommendations from colleagues or the sales departments of the Healthcare IT companies which include Athenahealth.

Earlier in the conference call, CEO Bush stated that they were ramping up the sales force during the first quarter of 2011 which should propel revenues higher. This may moderate the stock's upside in the short-term because of the added SG&A expenses, but in the long run, it should pad Atheahealth's coffers.

In its most recent 10-K, they discuss the competition: "Other nationwide competitors have begun introducing services they refer to as 'on-demand' or 'software-as-a-service' models, under which software is centrally hosted and services are provided from central locations.". I believe this is a plus for Athenahealth because other HIT vendors are playing catch-up to their first-mover advantage. Athenahealth was founded in 1997 and has a 14 year head start in cloud computing and I believe that prospective clients would consider this a positive when deciding on who would be the best suited software provider for them. This could be especially true for individual physicians who may opt for cloud computing because no IT department is required to host, maintain and update the software. All you need is a browser and a broadband connection.

As far as both large and small hospitals with conventional legacy software systems, Athenahealth has an answer for that - Microsoft (MSFT). The two companies have a new partnership that connects Athenahealth's cloud based services with Microsoft's Amalga platform which is an enterprise health intelligence platform that collects data from disparate IT systems. This levels the playing field for Athenahealth and puts them on flat footing when vying for market share with more established enterprise HIT providers. They are in a great position to take advantage of the HITECH Act and all that it offers for revenue and earnings growth in the next five years.

So what don't all of these analysts like about Athenahealth? I really can't figure that out, but can only surmise that it's from a valuation perspective. As a momentum investor, I wouldn't think that it's PEG Ratio of 1.8 would make you hyper-ventilate, maybe make your palms sweaty, but that's the nature of momentum investing. I'm a value investor and believe that the market is due for a correction, so I'll let that scenario play out before I allocate my cash position. When and if that situation happens, I would think that Athenahealth would be a candidate for a trophy stock with ample upside potential. This company takes it to another level.

Tuesday, March 1, 2011

Illumina: From Outer Space

There's something about a high flying stock with the type of technology that only a Martian could engineer that piques the interest of most investors. That's because these equities have a lot of growth behind them and that is where the action is if you want to make money. Warren Buffett suggests to stay within your "circle of competence", which basically translates into, "invest in what you know", but that is difficult in the space age world in which we live where technology advances at the speed of light.

Illumina (ILMN) is one of those stocks that seems to have invaded us from the outer limits and the maker of next generation DNA sequencers has had a torrid advance in the last six years, rising from $2 in 2005 to it's current price of $70. Illumina has always intrigued me and I've followed it closely for years, but have refrained from buying it because I've been of the bearish persuasion of late. Recent developments in the security have made me take a closer look at it and I still like what I see.

These developments are the facts that it's been downgraded twice in the last six weeks (which I like as a value investor because it tends to bring the price down), and, Illumina's inclusion in the Investor's Business Daily top 50 stock picks where it ranks 25. This seems like it could be conflicting information if you are a momentum investor, but if momentum is what you want, momentum is what is has. Illumina's ranking has pegged the meters in the Investor's Business Daily evaluation process with relative price strength and earnings growth near 100 on a scale that can go no further. This company is a direct play on 'personalized medicine', and I can see why investors are enamored with the stock.

Personalized medicine is a relatively new but rapidly advancing field of healthcare that utilizes a patient's unique genomic, genetic and environmental information to determine what medication is best suited for them. It is already being used with some cancer patients to evaluate their likelihood of serious reactions to prescribed pharmaceuticals. Besides cancer, personalized medicine is also attempting to fight heart disease and diabetes. Other markets Illumina is tapping for an expansion of business are forensics and agriculture, both in their infancy stages in regards to genomics.

What I find most impressive is that in addition to its current client base of large laboratories, Illumina is launching a scaled down, but more affordable sequencer for smaller labs which should be a boon for revenues. To compliment the new sequencer, a beefed up R&D budget has contributed to numerous new products coming to market. Citigroup Global Markets estimates that Illumina commandeers a 50%-60% share of the key growth areas in the life sciences research market and its closest competitor Life Technology Corporation (LIFE) has only a 20% slice.

I like my stocks inexpensive on a P/E basis and Illumina gives me the heebie jeebies where valuations are concerned, but you may be from a different school, so let's get some perspective because this stock has legs - for now. At its current quotation of roughly $70/share, Illumina has a P/E Ratio of 51 for 2011 and 42 for 2012 based on the average earnings estimates of the 23 analysts that cover the stock as reported on Yahoo Finance. Those may seem high, but when you look at the PEG (price/earnings/growth) Ratios, Illumina looks much more affordable. With a five year CAGR at an impressive 27.5%, the 2011 PEG Ratio is 1.8, while 2012 is 1.53. That's not out of the stratosphere, and if you use the rule of thumb to sell when the PEG Ratio reaches 2, there's still room to run. So what's not to like about it?

If you are a value investor, what would seem to be a plus for a momentum investor, is a negative for you, and that negative is its inclusion in the Investor's Business Daily top 50 stock picks. Stocks on this list usually have a fairly short shelf life and come back down to lower price levels in the matter of about a month or two according to my casual observations. Sometimes they stay up there longer, but for a majority of stocks in the IBD 50, the party doesn't last very long. You may be able to pick up Illumina at a much more advantageous price in the not too distant future, especially if we get a market correction in the near term.

Another red flag for Illumina is what appears to be one of its big strengths and that is its installed customer base. According to Citigroup Global Markets: "Roughly 72% of Illumina's revenues come from the academic and government end markets.....Because of its higher dependence on those markets, any large swings in government stimulus could have greater impact on Illumina relative to its peers.". In a Februray 25th ValueLine analysis they report: " believes that funds made available to the National Institutes of Health through the American Recovery and Reinvestment Act of 2009 should continue to beef up orders until 2012.". That only gives it 10 more months until Illumina's clients need more funding. If the GOP has its way, there may be some cutbacks and that would put pressure on the stock.

As a value investor, Illumina is out of my price range, but I am continuing to monitor it. With its lofty P/E Ratio, it could get whacked if it misses a quarter on either the sales or earnings side. I realize this is a tail event with low probability, but it's how I shop for good companies that get slightly ahead of themselves. That's how I bought Cisco (CSCO), EMC (EMC) and Oracle (ORCL) back in the boom. If you are a momentum investor and a member of the Illumina fan club, then this would be a terrific stock to put in your portfolio if you are nimble enough to get out at the appropriate time.