Tuesday, April 26, 2011

What Would Ben Graham Do Now?

Money talks. So does What Would Ben Graham Do Now? A New Value Investing Playbook For A Global Age, by Jeffrey Towson, published by FT Press. Scheduled to be released in early June (I received an advance copy), the book really differentiates itself from the pack of finance and investing books I've read of late. Full of fresh ideas, this insightful and informative publication is not what it seems on the surface.

From just looking at the title, I assumed as a retail investor I would be able to take out my spreadsheet and learn a few tricks. Well, I learned plenty of tricks, but they weren't meant for somebody in my modest income bracket. This book is best utilized by whales, sharks, movers and shakers, the big money dealers - whatever you want to call them - people in the position of financial power whether they be in a hedge fund, pension plan, Fortune 100 company, venture capital firm or private equity organization. That said, I thought What Would Ben Graham Do Now? was fascinating and that the writer made the most of his opportunity.

Towson is the former point man for Prince Waleed of Saudi Arabia, one of the richest men in the world. He developed over $15 billion of investments across multiple geographies which included the Middle East, North Africa and the Asia Pacific region for Waleed, nicknamed "The Arabian Warren Buffett" by Time Magazine. He is now the managing partner of the eponymous Towson Group based in New York, Dubai and Shanghai, and has culminated his experience into a part game plan, part textbook for those with deep pockets.

It is important to note that although this publication is meant to be a textbook, it reads more like a novel with Venn Diagrams and flow charts. Easily stated and understood, I would think that investors of all persuasions could benefit from this book if they are interested in where the global markets are heading in the next 20-30 years.

One of the many things I enjoyed about What Would Ben Graham Do Now? is that Towson doesn't go over old material. If you are a value investor, he assumes that you are already familiar with the teachings of Benjamin Graham and doesn't rehash old formulas, especially when breaking down financial statements. In fact, he spends very little time crunching numbers. His main piece of advice is to analyze a company's financials in the developing countries by turning back the clock and look at the balance sheet the way that accountants and analysts used to, not the income statement that is so popular in today's world. Reason being is that like America in the 1800's and early 20th Century, the developing countries are mostly industrial infrastructure and natural resource plays.

Although notable global tycoons like Prince Waleed, Warren Buffett and Carlos Slim have used their reputations to close sizable financial deals internationally (think Buffett negotiating a 10% stake in China's BYD), Towson believes that the best deals are done in smaller, privately owned companies. He likes to run into burning buildings and seeks opportunities everybody else avoids and utilizes what he calls "5 to 20" investments. This basically means you invest $5 million in a privately held family business that is selling below inartistic value, infuse good old American know-how in the form of better management or brand identity, then reap a $20 million profit - over the long term. There's no flipping involved here unless the company grows to IPO status.

Towson contends the main way to do business in these frontier markets is by going back to another era and network, press the flesh and be above board in your relationships. This is the way they do business over there. Don't be the Ugly American. As a member of the developed nations you are an outsider but have things to contribute like management skills, brand identity and technology. However, it's a hyper-competitive, fast and loose environment you are dealing with. That's why he looks for small, private companies that have a monopoly status in some exotic locale.

As far as the overall investing environment is concerned, the author thinks that since the end of World Wat II we have been primarily in a unipolar ecosystem, and, that as we move further into the future, we will be experiencing a multipolar financial world. East will clash with West and those from the developed nations that wish to make the most money, will have to put up with emerging market norms like crony capitalism. Political power is often concentrated with the privileged few in the developing world, and you must make inroads with the local governments if you wish to succeed.

I really liked this book. I thought it made me more informed on what is going on in cross-border finance. I think it would be an excellent tool for not only those that have the capability of doing large financial deals, but business students in general. A job well done.

Thursday, April 21, 2011

Let Off The Leash

Almost every financial book I've read the past two years has suggested that we are in for rough sledding in regards to where the economy is heading for the next decade. Some of these publications were written by academics, but for the most part, they have been penned by investors with plenty of assets under management and a wealth of experience. If this were a self-fulfilling prophecy, I'd be in the chips by now with my short positions, but the market is a different animal than the economy. As is, I'm in the belly of the beast as the market surges ahead.

Since the beginning of the year I've been kicking the tires on some of the stocks I'd like to buy for my portfolio once the indexes get to more reasonable levels. Most of these equities are in the biotech, wireless, cloud computing and clean energy areas. You could buy blindly into these sectors with ETFs and probably still make some money in the short-term. These industries have gotten their true due from market participants since the March 2009 lows and equity prices have escalated because this is where the growth is. They've been a winning hand and rightfully so. American ingenuity has not gone away and will be here for the foreseeable future if companies like Apple (AAPL), Acme Packet (APKT) and Salesforce.com (CRM) have anything to do about it.

Most of the organizations I have analyzed of late have extremely high valuations for now, next year, and even into 2013. They are great companies, but with P/E Ratios over one hundred in some cases, I just won't go near them. Apple is the exception, but I contend they've reached the law of large numbers and are now ranked third in regards to market capitalization globally. I think that I'm making a reasonable assumption that we will get a pullback and that it may be significant. However, be warned, I've made this assumption for a year and a half with very little success except for the occasional mini correction. That's not going to get me in the Barron's Roundtable.

From doing all of the research for my postings, I am of the belief that we are at the threshold of a new era of growth in technology, specifically in cloud computing. Cloud computing and the buildout of the backbone of Internet 2.0 will encompass every industry and every person that uses a computer, laptop, smartphone or tablet. It touches consumers more so than the personal computer revolution did because the outset of PC adaption was basically a corporate phenomenon. The introduction of word processing and spreadsheet programs like Lotus 1-2-3 made the PC popular in the cubicles across the enterprise landscape. Made life much more easier. They don't cook the books anymore. It's all done with Quicken and Excel.

It took until the Internet was made accessible to the mainstream before your average Joe on the street became wired. A large percentage of the population now has some sort of device that accesses the World Wide Web. Because the cloud enables corporations to save money, it will be implemented and you will be assimilated or left behind. It's a whole new ballgame.

Not every cloud computing stock has gottten ahead of itself. F5 Networks (FFIV) just had a blowout quarter and I still believe they are reasonably valued, if not undervalued. I am still hesitant to add these shares to the Ithaca Experiment portfolio because when the market crashed in 2008-2009, all P/E Ratios contracted. I am banking on this scenario unfolding again to some extent in the next year or so. Maybe the market won't fall off of a cliff again, but it may grind slowly down.

To reiterate what I've stated in previous postings concerning the economy, I think that this era is more like the 1930's or 1970's, not the 1960's or 1990's. Technology has been on an upward trajectory since the early 1950's, but that doesn't always translate into higher stock prices, at least for the overall market. Some stocks will do well, and they already have the past two years. The issue is whether they will be able to hold their lofty valuations. I am banking that they will come back down to more reasonable metrics.

In the meantime, I will continue to evaluate securities I either find interesting, or that are popular and I don't understand their technology. After all, if my theory is right and we are in a new technology era, there will be things that I will want to know to stay ahead of the curve. I hope I can keep you informed, too.

Monday, April 18, 2011

VeriFone Systems: Your Cash Ain't Nothing But Trash

It seems like I see VeriFone Systems (PAY) products every time I use my credit card. Swipe your card at the gas pump, grocery store, restaurants (both casual dining and fast food), retail stores and even in taxis, you are probably using a VeriFone Systems point-of-purchase reader. Since its inception in 1981, the company has, "...designed and marketed system solutions that facilitate the long-term shift toward electronic payment transactions and away from cash and checks.", so says the 10-K. When you hear the expression 'your cash is no good here', VeriFone really means it. It's been a mission of the company to get the genral public to use only plasitc, either debit or credit cards, and has been very successful in their endeavor.

Their stock has experienced a caffeinated run since the early part of May 2010 when it was selling for $15.50. It's currently trading in the mid $50's after a series of blowout quarters. There is also the anticipation of their intermediary position between consumers and financial cartels with Near Field Communications (NFC) capabilities on smartphones, and, the profits they may reap as retailers upgrade their sytems. NFC is the nascent technology that allows you to make credit card payments with your handheld mobile device among other things. Just wave your cellphone near a point-of-purchase terminal and voila, your transaction is complete. No cash, no credit cards.

NFC has been center stage of late with the introduction of Isis, a joint venture of AT&T (T), T-Mobile and Verizon (VZ) that is developing the technology to not only accept payments via smartphones, but to also include value-added services like advertising and coupons. VeriFone CEO Douglas Bergeron articulated during the last conference call: "The Isis joint venture alone represents a market reach covering 76% of U.S. mobile phone subscribers and a distribution network of over 20,000 retail stores across America. When you add the Google (GOOG), Apple (AAPL) and PayPal brands and their prospective global reach, it becomes quite clear we are at a tipping point where mobile payments can begin to pay for goods and services.".

Last month The Wall Street Journal reported that Google, MasterCard (MA) and CitiGroup (C) were teaming up to embed NFC technology in Android devices, and, use VeriFone readers to process the payments in a pilot program. Neither Google or VeriFone will reap the rewards of transaction fees, but they will be able collect data from handset users and transmit the above mentioned advertisements and coupons to end users. CEO Bergeron declined to comment on VeriFone's relationship with Google in that same article, but in 4/12/11 Reuters post said: "The more complexity that moves to the point-of-sale, the better for us. A system that adds NFC capabilities is obviously higher margin than something that just swipes a credit card.".

Bergeron also stated that: "The typical refresh cycle for payment terminals is 3-4 years and if NFC succeeds, VeriFone would have the opportunity to speed up that cycle.". This compounds the dynamic that 40%-45% of all credit card transactions domestically are still performed by integrated cash register solutions. There is plenty of market share for VeriFone to grab as the world adapts to the 21st Century - in the America and overseas.

VeriFone Systems currently ranks: "... number 2 in the global market for payment systems. But it should take over the top spot when it closes its $485 million buyout of Hypercom, a maker of point-of-sale equipment...", as reported in a recent Investor's Business Daily article. This relationship between VeriFone and Hypercom is no shotgun wedding. In fact, in the two weeks since the article was published, Hypercom did their version of a prenup and sold its U.S. payment systems business to Ingenico S.A. (ING.PA) in order to clear the path for the merger to be approved. It is slated to close in the second half of 2011.

If you believe that the added muscle and reach of Hypercom, and the evolution of NFC technology may boost the top and bottom lines for VeriFone Systems, you may be right, but not immediately. The potential merger could put pressure on the stock as the two companies amalgamate their resources. Although The Yankee Group predicts the value of NFC-based transactions is likely to increase from $27 million in 2010 to $40 billion in 2014, there is no guarantee that retailers will adopt the technology as fast as The Yankee Group is forecasting unless service providers win over the merchants.

In the 3/1/11 conference call, CEO Bergeron addressed the issue: "These merchants won't willingly migrate to alternative payment schemes and value-added services unless they are seemingly compliant with traditional ways to pay at point-of-sale and don't add to the complexity and expense of payment acceptance. Service providers have continually tried to force feed new payment and security requirements on merchants, who have been telling us that frankly, they've had enough.".

On a valuation level VeriFone Systems is reasonably priced at $52/share. Its consensus earnings estimate for 2011 as reported on Yahoo Finance is $1.81, which gives it a P/E Ratio of 28. Going forward one year, earnings estimates are $2.17, which gives at a P/E of 24 and a growth rate of about 25%. So the PEG Ratio (price/earnings/growth) is roughly one - right about where you want it if you are considering this stock for your portfolio.

It should be noted that VeriFone Sytems has basically operated at a loss for most of their duration, although 2010 and 2011 were very profitable. One tidbit I dug up in the conference call courtesy of Mr. Bergeron concerned the lumpy growth the company has experienced in the past. When buttonholed by an analyst about the tough comps the company will surely experience going forward (they grew 43% over last year), Bergeron responded: "No, I don't think we'll see 43% year-over-year growth. But double digits, I think, a fairly low hurdle, and I'm pretty confident that that's in the cards for the foreseeable future.".

If you do own the stock, or, are thinking of buying it, be aware that it may be a roller coaster ride if you are a long-term investor. When looking at VeriFone Systems, you should also take into consideration it's primarily a hardware stock with a P/E Ratio of 28. Contrast that with Apple and their P/E Ratio of 15. They both have approximately the same growth rates.

Investors should also know that they were rocked by an accounting scandal in 2007-2008 and had to restate earnings which crushed the stock. This may change the complexion of your thinking, but it's what lies ahead that is important for them. Bergeron has been CEO since 2001, and, seems to have righted the ship after the CFO and General Counsel were let go in the aftermath of the bookkeeping chicanery.

There is a legitimate debate as to where the market is heading, if anywhere. I heard Ken Fisher on CNBC on Tuesday and he believes we are going to flatline this year. Then you get soothsayers like Harry Dent who are extremely bearish on the second half of the year, and conversely, the bulls like Jim Paulsen of Wells Capital Management who see no end in sight for the current run. Which direction this market goes will have a large impact on VeriFone systems because of their Beta of 1.98. If the market keeps rising, this equity will continue to outperform the S&P 500. However, if the market contracts, look out below. This stock could drop considerably.

Saturday, April 16, 2011

High Fives For F5

F5 Networks (FFIV) is a great example of how fickle Wall Street can be. In late December, early January it was the flavor of the month selling at $146/share, and on a valuation basis, traded at a forward P/E Ratio of 40 with an earnings growth rate of approximately 45%. That's not outlandish. However, in their 1/19/11 conference call, they stated that revenues would be slightly below heightened expectations, and the stock has been pummeled. It closed at $94.50 on Friday. To say it's been in the penalty box would be an understatement; it's more like on the disabled list.

If you think its get up and go got up and went, you may be mistaken. F5 Networks is still alive and kicking. There's a lot of life left in the company and in the potential appreciation of its equity value. Benjamin Graham wrote that a stock can drop 50% or thereabouts for no justified reason, and although F5 Networks did miss on the revenues side because of seasonality issues, it's only selling at a 2011 P/E Ratio of 26 based on consensus earnings estimates on Yahoo Finance. With a PEG Ratio of under 1 and as the leader in their industry, I think this security deserves a closer examination.

I contend that corporations like F5 Networks have the technology of our times, at least in the IT space. If you go back 15 years, you'll remember that companies like Cisco (CSCO), EMC (EMC) and Oracle (ORCL) were doing all of the behind the scenes heavy lifting that made our lives so much easier. Investors were paid handsomely by betting on these organizations. It's not like these companies aren't viable anymore. They're still industry titans, but got very big, and, the law of large numbers has caught up to them in regards to compelling growth stories. It's the young upstarts like F5 Networks that are building the backbone for Internet 2.0 and have the growth to show for it. Cisco is F5's largest competitor and has a 3-5 year CAGR of 9% according to ValueLine. F5's CAGR is 31% over the same time horizon. Who would you rather invest in?

According to their most recent 10-K: "F5 Networks is a leading provider of technology that optimizes the delivery of network-based applications and the security, performance and availability of servers, data storage devices and other network resources.". This basically means they are in cloud computing. How big of a leading provider are they? The latest Standard & Poor's analysis reports: "Through constant share gains over the past five years, FFIV has garnered a dominant (number one) position in the market - about 50% as of the third quarter of 2010.".

I recently wrote a post about Acme Packet (APKT) and just assumed that they were rivals of F5 Networks. In doing research for this article, I have discovered that this is not necessarily true. Acme Packet and their Session Border Controllers disassembles, routes and reassembles data transmissions, which is a relatively unintelligent process. "By contrast, application delivery networking...requires intelligent systems capable of performing a broad array of functions.", so says the F5 10-K. These functions include load balancing, health checking (monitoring the performance of servers and applications) and encompasses a growing number of functions that have traditionally been done by the server or application. Acme Packet and F5 Networks work in tandem.

Application traffic management tools make networks less costly to manage and more efficient in traffic flow, particularly as the industry migrates to a more virtualized network infrastructure (to paraphrase the freshest S&P analysis). In that last conference call that caused the hemorrhaging in the stock price, CEO John McAdam articulates: "The market growth drivers for our business remains very much intact and include continued increase in storage requirements, global datacenter consolidation projects, growth in mobile and mobile applications, and increasing awareness of the importance and need for application security...".

ValueLine estimates that F5 Networks' addressable market will advance at a 20% rate out to 2013-2015 and that: "...its opportunity as the market leader appears to be quite lucrative if F5 continues to resonate with its customers.". According to the 10-K, F5 plans to: "...continue investing in programs to promote the F5 brand and make it synonymous with superior technology, high quality customer service, trusted advice and definitive business value.". I think that would resonate with clients.

To reach more customers and to compete against the likes of Cisco and other large competitors, they have developed strategic partnerships with enterprise software vendors such as Microsoft (MSFT), Oracle and SAP (SAP) to take advantage of their already entrenched customer bases. With an R&D budget at 13.5% of revenues and plenty of patents, there's a lot to like about F5 Networks as a client or as an investor.

On the analyst side, there seems to be some contradicting impulses on what you should be doing in regards to F5. Out of the 34 analysts that cover the stock, only 18 have a buy or strong buy rating, while 13 have a hold, and, 3 consider it an underperforming entity. Besides the most recent quarter that was a miss on revenues, there is the upcoming conference call on Wednesday 4/20/11 to discuss the 1st quarter. There are concerns that F5's 7% of total sales that emanate from Japan will be on the light side because of the recent earthquake and aftershocks. This could put additional pressure on the stock.

If we look out to 2012, the consensus earnings estimate for F5 Networks is $4.34 which gives it a P/E Ratio of 21.6 for next year. That's a bargain basement price for a stock that is expected to grow over 30% in that time frame, especially for a market leader in a growth industry.

If this is the type of security that interests you, then it's your decision as to whether you want to pull the trigger on F5 Networks before Wednesday's 1st quarter conference call. My strategy is to wait because I believe this time in investing history is more like 1937, not 1997. My theory is that the markets are due for a considerable pullback and P/E Ratios will contract even more. However, when I do begin to purchase individual securities again, a company like F5 Networks will take a commanding position in my portfolio.

Wednesday, April 13, 2011

Super Boom

It seems like every investing book I read is a doom and gloom, down-at-the-heel assessment of where the market is heading for the next decade, so I took a flier on Super Boom: Why The DOW Will Hit 38,820 And How You Can Profit From It. Written by Jeffrey Hirsch and published by John Wiley & Sons, both of the annual Stock Trader's Almanac fame, the sub-title is a bit misleading because it is not a primrose path that Hirsch projects for the market in order to reach his target of almost 39,000 by 2025. In fact, the author believes there will be inclement conditions for the indices going forward, and that we may very well test the market lows of early March 2009.

In the first chapter of Super Boom Hirsch predicts that: "We expect the Dow to push into the 13,000 to 14,000 range in the first six months of 2011 before it buckles....into another bear market." Later on in the book he focuses on the dire prognostications of two current bears, Robert Prechter and Harry Dent, and, gives his own assessment as to where the market will drop: "I believe that the 2009 intraday low of 6,470 or thereabout will hold...".

In going back to Prechter and Dent, the author writes: "A drop in the Dow from the recent high of about 11,500 to Dent's 3,800 or Prechter's 1,000 would equate to catastrophic losses of 67 percent and 91 percent, respectively.". Hirsch doesn't foresee losses of biblical proportions like the other two clairvoyants, but concurs with, "...the general concept of restrained economic growth and a lid on stock prices for the next several years.". All three think the market is like a bomb that's ready to blow and equity prices will snowball to new lows in the not too distant future.

So when does Mr. Hirsch think this ascent to 38,820 will commence?: "The next super boom will begin around 2017...". That's six years from now and if his double dip scenario pans out according to his timetable of the second half of 2011, investors with a long-term horizon will suffer a lot of pain, torture and agony in their portfolios. So much for reading a book that isn't all doom and gloom.

The author gives some telltale signs of when this market levitation will explode: when the P/E Ratio of the Dow hits single digits, when housing recovers and when Consumer Confidence reaches 90. He also goes on to say: "...the calculus for a super boom forecast: the combination of peacetime, supportive government policies, ubiquitous technology, and inflation.".

What I have just written about is basically the essence of Super Boom, another market crash, then a significant rebound. Hirsch could have said it all in a 50 page pamphlet or e-book, but instead, he includes about 125 pages of fluff which is why I can not recommend investors buying this book. Half the publication is an homage to his father Yale Hirsch who founded The Stock Trader's Almanac and made a couple of prescient calls like the market bottom in 1974.

Too much of Super Boom is filler, like reprints of some of Hirsch the elder's old newsletters from the 1970's. There is also a chapter dedicated to critiquing James Glassman and Kevin Hassett's Dow 36,000 published in 1999. You get some inflation history of the 20th Century, too, but it's been done too many times before. It's like you give a guy a hammer and all of the sudden everything needs hammering.

What I couldn't understand is how a guy that puts out an all-star manual like The Stock Trader's Almanac comes up with a dubious product like Super Boom. It's beyond comprehension. However, as far as his market predictions are concerned, I believe Hirsch is right that we will see a consolidation, if not a crash in the markets, and then we will experience a significant rebound afterwards. I know it's his first book, so I'll give him the benefit of the doubt in his next effort, but I don't like to mince words, so do yourself a favor and take a pass on this one.

Monday, April 11, 2011

American Superconductor: The Bloom Is Off The Rose

American Superconductor (AMSC) was an accident waiting to happen. If you own the stock or follow it, you know exactly what I'm talking about. Last week on April 5th it closed at $24.88. The very next day it fell 50% to $12.54 and has since bounced back to the $13.50 range. That's a mind blowing loss. The reason the once high-flier got its wings clipped (it was selling at $43 fifteen months ago), is because its biggest customer Sinovel declined to receive American Superconductor components for their wind turbines stemming from an inventory buildup.

Sinovel accounts for over 70% of American Superconductor's revenues. According to a ValueLine update: "Negotiations are now under way as to whether the company will will be accepting future shipments and when it will pay for receivables due.". There is also no guarantee that Sinovel will continue to use American Superconductor as their supplier. It's not a pretty picture.

In a recent Reuters article they state, "For months, analysts have warned that American Superconductor's customer concentration is a huge risk.". Well, the damage is done, its reputation is sullied and there is no telling how long it will take to get American Superconductor off of the mat. There are certain questions to be asked. First, is it still a viable company? Secondly, where is their growth going to come from? Thirdly, is $13.50 or thereabouts an inviting price for the stock?

I contend that American Superconductor is still a viable company because they remain a leader in a viable industry - renewable energy. Maybe they aren't as large of a leader as they were prior to last week, but they are in a young industry with a lot of room for growth. With the problems of disposing of nuclear waste and the issues of carbon emissions from fossil fuels, renewable energy is the future.

If you aren't familiar with American Superconductor's business model they provide: "...wind turbine designs and electrical control systems....The company also offers a host of smart-grid technologies, including superconductor power cable systems, grid-level surge protectors, and power electronic-based voltage stabilization systems for power grid operators.", according to a recent TheStreet ratings report.

I became aware of American Superconductor a couple of years ago from reading about it in three different investing books covering the green-tech "revolution". The most notable of the trio is Clean Money by John Rubino and is a very worthwhile read if you are interested in investing in the sector. I don't believe it is a coincidence that American Superconductor along with the rest of the green-tech stocks had significant gains right after these publications were released. Investors got starry eyed with the prospect of all the potential profits emanating from this area, and perhaps the stocks suffered from the too much, too soon syndrome. American Superconductor alone had an average annual P/E ratio of 86 in 2009 because speculators bid up the stock in its first year of profitability.

I believe that in order to examine American Superconductor's growth potential going forward, we have to make an assumption that Sinovel will not be in the picture. If they do come back into the fold at a later date, then that will be gravy, but the analyst reports I've read don't believe that Sinovel will work down their excess inventory for at least another six months. Before last week, 80% of American Superconductor's business came from their wind turbine division: 70% from Sinovel and 10% from other customers. The remaining 20% of sales is from the power grid division which is growing 60% year-over-year according to their most recent earnings call transcript.

If we do the math here, the remaining 30% of the business now accounts for 100% of future revenues, 66% from the power grid division with growth growing like gangbusters. That means that 33% of revenues will now constitute all other clients in the wind turbine division. American Superconductor will focus their marketing efforts in the Asia-Pacific region, specifically China. They "expect increased revenue contribution from Chinese customers such as XJ Group...Shenyang Blower Works...Dongfang Turbine Company...Beijing JINGCHENG New Energy.", as stated in the earlier mentioned conference call.

They also recently closed orders with Doosan Heavy Industries and Hyundai Heavy Industries in Korea, and, Inox Wind in India. There are still sales to be had in the wind turbine division, it's just not the booming business it was when they had a nice revenue stream from Sinovel. There is also the prospect of landing Goldwind, China's second-largest wind turbine maker, but this all hinges on their ability to acquire Finish company The Switch as reported in ValueLine. Because of the Sinovel fiasco, they may not have enough cash available to pull off the deal. However, wind turbines still show promise, especially after the nuclear situation in Japan.

Every broker report I read which includes Citigroup Global Markets, Morgan/Stanley and ValueLine believes that American Superconductor will operate in the red for at least another year if not longer. Valuations based on 2011 earnings (fiscal year is March 2011-march 2012) are not feasible because of this. Therefore, to value the stock, we'll have to use the Price/Sales metric if you wish to consider a company for your portfolio that does not make a profit.

Citigroup Global Markets is the only report I have that projects sales for fiscal 2011, so we'll have to use these numbers as opposed to the Yahoo Finance consensus. Citigroup states that their previous estimates for American Superconductor's 2011 revenues were $464 million and have now reduced that number to $253 million. With 52 million shares outstanding, that gives us a sales/share of $4.9 and a price/sales of 2.8. In addition to this, they may have to issue new shares to complete The Switch deal which would dilute sales/share even further and increase the price/sales ratio.

I realize that it is open season on American Superconductor and I'm reluctant to join the fray, but with the high price/sales ratio, lack of earnings visibility and overall pressure on the stock market, I'm inclined to take a more sidelined approach to this equity. Their next conference call is in early May and that should shed more light on the situation and perhaps goose it out of its vegetative state. However, at its current valuation, I consider American Superconductor unattractive, if not radioactive because it seems to have lost its way.

Sunday, April 10, 2011

Better Good Than Lucky

In the introduction of Better Good Than Lucky author Charles Rotblut writes: "The reason for writing this book is to provide investors with a single book that is easy to read and based on sound investing theories and thought.". Well, he accomplished his objective and more. Published by W&A Publishing and Traders Press, Better Good Than Lucky amalgamates the ideas of financial pioneers like Harry Markowitz, Benjamin Graham and Philip Fisher, and the final outcome is an outstanding primer to add to your investing repertoire. I wish I had a handy tool like this publication when I was beginning my investing education. Intermediate investors may find this book of value, too, if they are not well versed in deciphering financial statements.

The author Charles Rotblut is a Chartered Financial Analyst who serves as vice president with the American Association of Individual Investors (AAII). If you aren't familiar with the AAII, they are the premier value investing organization globally. No technical analysis or momentum investing in this book, which was fine by me. On a personal note, I was schooled in bottom up, fundamental analysis of financial securities so I'm a bit biased in my preference for value investing. That said, let's take a look at what Mr. Rotblut has to offer.

Although the book is a melting pot of ideas, each chapter is a snapshot of a distinct concept in wealth creation. All I can tell you is that you get a lot of practical, common sense advice when dealing with industry sell-side analysts, money managers, investment advisers (stock brokers) and financial gurus like newsletter writers and bloggers. Mr. Rotblut gives the pros and cons of utilizing the services of each entity and doesn't really take a stance either way. He just paints a picture for you and lets the reader make their own decisions. This is just in the first chapter and he is consistent with his impartial leanings throughout Better Good Than Lucky.

If you have a strong accounting background, then the middle section of the book will not be of much value to you because it covers income statements, balance statements and cash flow statements. It also presents everything you always wanted to know about a 10-K but were afraid to ask. However, if you are like the rest of us and never went beyond Accounting 101 back in your school days, then you will be pleasantly pleased with how clear and concise Mr. Rotblut presents the information. I think that all investors whether they be beginning, intermediate or advanced would get a lot out of this section. The chapters aren't long, only about 10 pages apiece, and, give you the basics on what you need to know in deciphering financials.

The last section of the book covers valuations: when to buy and when to sell. The author favors Price/Earnings and Price/Book Ratios and also writes a very nice piece on The Discounted Cash Flow Model. If you've wondered how to compute The Discounted Cash Flow Model, go no further than Better Good Than Lucky. Mr. Rotblut cautions about using long-range forecasts because, even from professional analysts, they are nothing more than educated guesses. It's good to use the trends from these industry insiders as a barometer as to where the stock may be heading, either up or down, but it's best to do your own homework. This book will show you how to do it.

I read a lot of investing books and usually after about a year after reading them, I usually donate them to the local library foundation. This one I'm going to keep for my personal library because it's a really great reference manual. The only issue I had with it was the price. The book is only about 170 pages and retails for $29.95, about $21 at Amazon. Since it's such a great teaching tool, the publisher offers bulk discounts, and if you are so inclined, you can contact them directly if you are from an academic institution or other large organization.

Thursday, April 7, 2011

The Ten Trillion Dollar Gamble

Investing maven and market tactician Russ Koesterich recently came out with The Ten Trillion Dollar Gamble published by McGraw Hill. I've seen Mr. Koesterich numerous times in guest spots on CNBC because of his position as the Global Chief Investment Strategist for iShares and he gets the job done with his first book. He knows where all the bodies are buried on Wall Street and shares his insight on where he believes the market is going the next decade and how to play it. Although there are a lot of statistics in this book, you don't get bogged down with information overkill while reading it which contributes to a very enjoyable piece of work.

The first three chapters of The Ten Trillion Dollar Gamble are dedicated to the debt the United States has accrued: "Even at the peak of the budget crisis in 1985, deficits were approximately 6 percent of the gross domestic product (GDP). In 2009 and 2010, the deficits were approximately 10 percent of the GDP, the largest since World War II.". Koesterich goes on to say: "So where do larger deficits leave the United States? Historically, chronically high deficits have been associated with slower economic growth, higher real interest rates, and in many cases, some amounts of inflation.".

The author's main thesis of the book is that inflation will be the buzz kill of the next ten years: "It takes a while for inflation to get going, so it is unlikely to accelerate before 2012, at the earliest, given the anemic state of bank lending and the slow growth in the money supply.". He gives himself a lot of wiggle room as to when this avalanche of inflation will come: "It is impossible to predict the exact timing, but we are already feeling the foreshocks, and it will be here before the end of the decade. We are in for a long period of slower growth and higher interest rates.". Not exactly going out on a limb, but it's difficult to forecast the economy. I thought he did a good job in backing up his theories with the data he presented.

The brunt of the book is dedicated to investments you can make to take advantage of the prophesied coming inflationary period. Koesterich breaks down your options into five sectors and allocates a chapter to each one in this order: cash, bonds, stocks, commodities and real estate. Because inflationary eras lend themselves to higher interest rates, the majority of your portfolio should be relegated to cash, like savings accounts, money markets and CDs. The shorter duration of your holding periods for these instruments, the better, to take advantage of the rising interest rates. That's good news for fixed income investors and let's not forget that interests rates spiked to around 15% in the early 1980's.

However, when it comes to bonds, there are few silver linings. The author states: "The first thing you should do to protect your portfolio in an environment of rising interest rates is to reduce you bond holdings, particularly U.S. Treasuries." He goes on later in the chapter to say: "...the U.S. fiscal debt represents two threats to the bond portion of your portfolio. All else being equal, a larger supply of Treasuries will push real yields up and and prices down, and the longer the duration of your bonds, the bigger will be to the hit to their price. The second threat is less certain but potentially more deadly. High government deficit spending often leads to inflation...If you need income, look at preferred dividend paying stocks as bond substitutes.".

That last sentence is basically the gist of the stock section of the book although there was one paragraph that really jumped out at me and I believe rings true: "The problem for equity investors going forward is that despite two brutal bear markets, U.S. stocks never really got that cheap, at least when compared to other market bottoms. So while stocks are reasonably priced today, they are nowhere near the bargain basement prices that typically mark the start of a new, long-term bull market." Koesterich contends that if you wish to invest in equities, then you should look beyond the borders of the United States.

These asset classes give you some examples of what you can encounter in The Ten Trillion Dollar Gamble. The author also covers commodities and basically says: "I would recommend that investors restrict their commodity investments to just two allocations: a broad commodity fund and gold." As for real estate, he doesn't think it's a wise investment with interest rates rising. A home is one thing. Falling housing prices is another: "Slower economic growth will reduce the demand for both residential and commercial real estate, and higher interest rates will harm affordability. If you already own a house and that house represents a nontrivial portion of your net worth, you probably have all of the real estate exposure you are going to want.".

As stated earlier, I liked the book and you will too.

Tuesday, April 5, 2011

Acme Packet: The Ghost In The Machine

To call Acme Packet's (APKT) 25 fold rise the last two years parabolic would be an understatement. It's been more like a vertical lift-off starting at $3/share in early 2009 and hitting $77 on 3/4/11. The stock ricocheted off the top of its all time high last month, and, you could have scooped it up for $67 on April 1st, but it has since bounced back to the $75 range. The digerati like this company and it comes as advertised. Their signature technology is the science of our time.

Back in the late 1990's George Gilder used to evangelise about the telecosm and how increased use of broadband would engulf us and dictate consumer and business behavior. Well that time has come. Acme Packet is serving notice that they are in an elite class of technology company and are building a global franchise. They seemed to be locked in to the fertile ground of growth which is the backbone for Internet 2.0.

If you aren't familiar with Acme Packet's technology, they are, "basically building a signaling network for the Internet.", says founder and CEO Andy Ory in a recent Investor's Business Daily article. They're like the traffic lights on the information superhighway. Essentially, they provide Session Border Controllers (SBCs) which reside at the outer seams between the loose confederation of IP networks that make up the World Wide Web. When you send anything digital, whether it be text, voice, picture or video, it is broken up into small packets that are sent via many different routes throughout cyberspace to get to its destination. Acme Packet's hardware and software enable that data to smoothly travel through the disparate connections on the Web and reconfigures the bits and bytes once they get to the end of their journey.

Infonetics Research estimates that, "Acme Packet's market area... is expected to grow to $865 million in 2014 from $326 million in 2010 for service providers and enterprises.", as reported in The Boston Business Journal. The article also went on to say that, "Competitors include Cisco Systems (CSCO) and Sonus Networks (SONS), but neither has anywhere near the market share of Acme Packet, which Infonetics puts at 62%.". Standard & Poor's concurs with this assessment of the company's dominant position and states that it is over 50%. In the 2010 annual report, Mr. Ory claims that they have nearly six times greater market share than any competitor. Whatever the number is, it's enormous and they have a big head start on their rivals which now includes Juniper Networks (JNPR). A battle royale is brewing, however, Acme Packet has first mover advantage.

Acme Packet's current customer list includes 92 of the top 100 telecom service providers in the world, along with 11 of Fortune 25 enterprises. The key takeaway from the latest conference call is the potential market ready to unfold in the next five years. CEO Ory estimates that more than $20 billion of legacy systems have been deployed globally to support the old voice landline telephone network and they will have to be replaced with the newer IP technology. In addition, they recently acquired a prized possession in Newfound Communications, an innovative provider of IP session recording technology and believe that this could significantly increase their addressable market, although not beginning until 2012.

Before we call Acme Packet a stock for the ages, I'm going to throw some cold water on the romance and check out the valuations. According to the average analyst estimates on Yahoo Finance, the company is slated to earn $1.08/share for 2011 and $1.44/share for 2012. That translates to a current P/E ratio of 69 and a forward P/E Ratio of 52. Not exactly sticker shock, but still very high when you take their estimated growth into consideration. CAGR for the next 5 years is projected to be 25%, but, I'll kick it up a notch to 30% just to give them the benefit of the doubt for our computations here. At 30% growth, we get a PEG Ratio (price/earnings/growth) of 2.3 for 2011 and 1.7 for 2012. Not too bad if you own it, but much too expensive if you want to buy it.

There's a lot to like about Acme Packet. Their opening gambit against more formidable opponents was not checkmate, but they've got their rivals scrambling to take advantage of the big land grab which is the buildout of the backbone of Internet 2.0. Acme Packet has a healthy R&D budget and a global reach. In fact, 40% of business is from international markets. Besides the competition, one large headwind they will be experiencing is managing their growth. They've already begun hiring in advance of the anticipation of amplification of business. SG&A expenses could put a damper on earnings going forward. There is also their high BETA of 1.45 according to Standard & Poor's. If the market corrects, small caps like Acme Packet will get hammered. You could pick it up at a much more reasonable valuation.

After doing a fairly substantial amount of research on market direction and valuation, I'm betting that P/E Ratios for individual securities and the indexes will contract in the next decade. That's why I am out of the market at the present time. However, there will be growth in some global market sectors. The expansion of Internet Protocol networks will probably buck the trend of any slowdowns in the global economy and Acme Packet will surely be a beneficiary. The question is, what do you want to pay for it and at what metric? That decision is entirely up to you.

Saturday, April 2, 2011

Dolby Laboratories: The Sounds Of Silence

Dolby Laboratories (DLB) has suffered a reversal of fortune since the beginning of the year. On January 3rd, the stock sold for $67/share and has since gone south closing at $48 at the end of trading on April 1st. That's roughly a 30% haircut for the quarter. The primary reason for the demise is that management guided earnings lower for fiscal 2011 because of a slowdown in PC sales which is a large market of theirs. In fact, 10% of their business comes from Microsoft (MSFT). Before you make a snap judgement and dismiss them as snakebitten, I'd like to take a look at the company because I believe that savvy investors with presence of mind may want to include Dolby Labs in a portfolio or watch list.

I'm old enough to remember when Dolby technology was introduced to the mass market back in the 1970's. It removed the hiss in the background of cassette recordings which was a major problem back in the day. Noise reduction in audio recordings is something we take for granted now with Dolby's de facto industry standard creating a much more enjoyable listening experience. Its technology is used in: "movie soundtracks, DVDs, television, satellite and cable broadcasts, video games and personal computers", as stated in the most recent ValueLine report. ValueLine's analysis also discusses Dolby's thrust into the new frontier of tablets and smartphones: "Management is focused on capitalizing on this emerging market, which should position Dolby for the long haul and lead to solid growth down the line.".

Dolby Laboratories' most significant revenue stream is from the licensing of their technology to other companies. Although licensing was as high as 84% of total sales in 2008, it has since decreased in steady increments the last three years to 77% in 2010. The reason for this reduction is that their products division has grown at a brisk pace and accounts for 20% of business now. According to a 3/26/11 Standard & Poor's report: "Product revenues involve the sales of digital media servers, which load, store, decrypt and decode digital film files for presentation on digital projectors in theaters, as well as sales of digital 3D products.". The remaining 3% of revenues comes from the services division.

I think there is a lot to like about this company: plenty of patents, over 10% of sales is allocated to R&D, a global presence with 66% of revenues spread out internationally to 85 countries, minimal debt and then there is the valuation. Earnings per share for 2010, 2011 and 2012 as reported and projected by Yahoo Finance break down to $2.46, $2.72 and $2.96 with a 5 year CAGR of 17%. This gives them a current P/E Ratio of 17.6 and a PEG Ratio (price/earnings/growth) of one. That's very reasonable, however, the stock keeps falling and needs a catalyst to not only stop the bleeding, but to propel Dolby Labs higher. I'm of the opinion that this may come from their subsidiary Via Licensing with it's major foothold in Near-Field Communications.

Articles about Near-Field Communications (NFC) are beginning to spring up on the Internet because both Google (GOOG) and Verifone (PAY) are going to test market the technology in an unspecified urban area using Google's Android operating system on smartphones, and, Verifone's point-of-purchase terminals. This is the science that enables you to make credit card purchases with your cellphone among other capabilities. It's already in use in Japan and some parts of Europe, and, is inevitable that it will be adopted here, too. As reported in a recent Wall Street Journal article: "California based market research group iSuppli predicts explosive growth for NFC technology over the next few years...iSuppli says that this year's worldwide shipment of 52.6 million NFC-equipped phones will quadruple to 220.1 million units in 2014. This means that 13.1% of all phones shipped will feature NFC, up from 4.1% in 2010.".

Via Licensing will benefit from the uptake in the use of NFC because they provide patent licences for any company that utilizes the technology. They get a cut of every single NFC enabled phone that is sold. Via Licensing is able to do this from their position as patent pool administrator for several broadcast, wireless and audio technologies which include NFC, RFID MPEG2 and 802.11 based WiFi. A patent pool, "... is a consortium of at least two companies agreeing to cross-license patents relating to a particular technology.", as reported by Wikipedia. It basically standardizes the industry. However, this does not necessarily mean Dolby Labs will earn huge amounts of money from this smartphone advancement, at least not at the outset, but may turn the tide on investor sentiment.

In the next 12 months when NFC technology becomes more of a household name to the consumer, investors may boost up the stock prices of most companies that reside within the sector. Just look at cloud computing or wireless today. Even if you are a minor player in these fields, the P/E Ratios of equities that are in these industries are astronomical. The fortune of a stock's sector plays a significant role in the price of a security. A tide that rises all boats if you will. I believe that when investor psychology kicks in, Dolby Laboratories will be a benefactor of the hype that will surround it. This is on top of the already great story they have to tell.

If you are a momentum investor, Dolby Laboratories is not the hot hand you want to be playing. As a value investor, a good, solid company that lost its luster is something you might want to take a look at. I know I like it, but not at $48 because I believe the stock is still a falling knife and continues to slide. I am also out of the market right now and am of the school we still haven't experienced that long awaited correction. Dolby is not the dog with the least fleas, but with its huge sphere of influence, is best in show.