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*** Executive Summary 5/23/11 ***
End of Days? – Harold Camping vs. LinkedIn
Valuation Lessons – LNKD vs. CSCO, INTC, IBM & MSFT
Reader Q&A – Is WWE Down for the Count?
Reader Q&A – Sectors & Industry Groups
San Francisco MoneyShow – Never too Early to Sign Up
“It has been a really tough weekend. I’m looking for answers.” So said a “flabbergasted” Harold Camping on Sunday afternoon, trying hard to explain why May 21 (at 6 p.m. in each time zone) turned out NOT to be the start of Judgment day and the rapture. The second time he has been off the mark (the first was in 1994 when he blamed a mathematical error), the 89-year old founder of Christian broadcaster Family Radio joins a long list of doom-and-gloom prognosticators that have seen their dire forecasts fail to come true. Oh well, at least we have December 21, 2012 (when the Mayan calendar prophesizes doomsday) to look forward to!
While I had to search his Web site and Wikipedia to find Mr. Camping’s biblical mathematical formula for determining the end of times, there was plenty of ink spilled over the past couple of days on a seemingly ominous portent for the equity markets. Probably a stretch to compare the two, I know, but more than a few folks are concerned about the feverish interest in the LinkedIn initial public offering, given that the dot.com boom of 1999 and early-2000 quickly turned into a bust, dragging the major market averages down in the process. Of course, the average stock (and followers of The Prudent Speculator!) did just fine, thank you, in 2000 and 2001.
Certainly, one small offering (7.8 million shares) does not a stampede bring, but it is pretty amazing that even after the underwriters ratcheted up the price on several occasions, LinkedIn more than doubled by the close from its $45 offering price on the first day of trading as 30 million shares changed hands. Volume settled down a bit on Friday as ‘only’ 8.5 million shares were traded. Simple math would suggest, then, that the shares turned over nearly five times in two days, making LinkedIn CEO Jeff Weiner look a little silly when he told Bloomberg News: “We spent a lot of time with the right kind of investors — folks who understand the story, the fundamentals, who are in it for the long haul.”
No doubt, the social networking company has a nice little business, but the day-traders and speculators playing in the stock obviously care little about the fundamentals, given that LinkedIn’s market capitalization is now $8.8 billion (a glance at the prospectus shows that total pro-forma shares outstanding total 94.5 million) versus revenue in the last 12 months of $292 million and net income of $15.6 million. What this means is that LinkedIn, which trades under the ticker symbol LNKD, is presently valued at 30 times revenue and 564 times earnings.
Though everyone and his brother is suggesting that LinkedIn’s shares are living on borrowed time and due to plunge (some might say that this is a contrarian buy signal!), it is interesting to consider the valuations associated with the large-cap technology stocks, all of which also pay a dividend, that we are presently recommending:
Cisco Systems (CSCO - $16.53): Price to Revenue = 2.1; Price to Earnings = 10.1
Intel (INTC- $23.22): Price to Revenue = 2.7; Price to Earnings = 10.7
International Business Machines (IBM - $170.16): Price to Revenue = 2.0; Price to Earnings = 14.2
Microsoft (MSFT - $24.49): Price to Revenue = 3.0; Price to Earnings = 9.8
If the four were awarded the same Price to Revenue multiple as LinkedIn, here is where they would be trading: CSCO: $237; INTC: $259; IBM: $2,563 & MSFT: $246. And if they somehow received the same P/E ratio, take a look at these resultant prices: CSCO: $923; INTC: $1,224; IBM: $6,757 & MSFT: $1,409. Clearly, those numbers are ridiculous, but this exercise illustrates why we always say it’s a market of stocks and not simply a stock market as our mission is to avoid the overvalued LinkedIn’s of the world, while being willing to embrace the undervalued companies. It’s a strategy that has served us well for more than three decades.
Of course, sometimes undervalued stocks become even cheaper as has been the case with World Wrestling Entertainment (WWE - $10.32), a source of several reader inquiries. In the last month, WWE reported Q1 2011 earnings that were generally in line with Street expectations, but the company highlighted some of the near-term headwinds like weakness in live event and pay-per-view revenue, the impact of the ongoing transition in its talent base and an increase in SG&A expenses. What really hurt the stock, however, was the fact that management slashed the dividend by 66% (from $0.36 to $0.12 per share per quarter). While the dividend cut wasn't unexpected, the magnitude of the decrease was quite disappointing.
Despite the bad news, WWE shares still yield 4.6% and pay investors to wait while the company fights its way through the difficult talent transition. There is no doubt that the turnaround will be quite a royal rumble, but we are not ready to put the stock in a sleeper hold, as we believe that there is still sizable capital appreciation potential and we feel comfortable that the current dividend is safe from further cuts as the WWE's cash generation is adequate to cover this return of capital while investing in the future of the business. That said, the shares did not make the latest newsletter buy list as there are many other names that we would favor for those looking to deploy new money.
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We’ve also had a couple of questions asked about our new Sector and Industry Group determinations. Here is one particularly interesting query and our response:
Q. I have to ask how you determine Industry Groups. I have often wondered because some of the classifications seemed odd to me. For example WFC is a Bank, yet BAC is a Diversified Financials, but ok.
However, your classification of URS in the Capital Goods group seems very wrong. URS is a Technical Services Company. Even your description of URS states that it is a "technical services organization." I assume that a Capital Goods company produces some sort of capital good like BA or CAT. Engineering and Construction companies do not produce any capital goods. They provide services to other companies that then sell products, be those products themselves a capital good or other product. Engineering and Construction companies like SHAW, TPC, and URS are inherently services providers.
I honestly don’t know if it matters, but it would seem to me that placing services companies in an Industry Group or Sector along with producers of Capital Goods could lead to faulty comparisons, even if you sub-group them in a “Construction & Engineering” Business.
A. We discussed the subject in some detail in the January edition of The Prudent Speculator (TPS 531) and we note that that our sector residency methodology is borrowed from the Global Industry Classification Standards (GICS - http://www2.standardandpoors.com/spf/pdf/index/GICS_methodology.pdf), which are managed by Standard & Poor’s. That is to say that we don’t slot individual companies into various categories.
That said, URS Corp. (URS - $43.95), in levels of increasing selectivity (each subsequent level exists within the one above), sits within the 1) Industrials sector, the 2) Capital Goods sub-sector, the Construction & Engineering industry and the 4) Construction & Engineering sub-industry. So there’s a bit of obfuscation there in that this is a services-oriented industry within what looks like a manufacturing-oriented sector. Alas, as a component of our desire to standardize our sector classifications, such irksome details will arise.
Rest assured that our valuation comparisons are made relative to both the lowest-level peer group as well as the overall investable equity universe. This is why our portfolios are not simply dominated by insurance companies that trade for single-digit P/E ratios or utility stocks that sport high dividend yields or retailers which boast low price-to-revenue ratios. In short, we strive to find attractively-priced stocks in each industry group.
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While it was nice to see several of our subscribers at the Las Vegas MoneyShow, I’m hoping for a greater turnout in San Francisco. I’ll be returning to the City by the Bay this year and I invite you to join me at The MoneyShow, August 10-12, 2011, at the San Francisco Marriott Marquis Hotel. Don't miss out...register FREE today and be sure to mention Priority code 022964! You can also sign up online at: https://secure.moneyshow.com/msc/sfms/registration.asp?sid=sfms11&scode=022964 |
