The 1K Challenge

A Young Investor's Journey Through the Stock Market

Facebook (FB): An Interesting Valuation Case Study

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In the infamous Facebook Initial Public Offering (IPO) where the stock exchange botched trade orders, and the investment bank snubbed it’s poorer customers, the dust has settled on a company that the market believed was overvalued.  Facebook, and it’s recent absurd seeming $1 billion acquisition of young start-up Instagram, provide an interesting backdrop to discuss market valuation, or how expensive / cheap a stock is.

Investopedia has a definition for market capitalization (usually said as ‘market cap’).  It’s just the number of shares times their share price at any given moment.  Facebook went public valued at $80 billion, which is about half the size of tech giants Microsoft or Google.  The best way to determine what that means is to consider a fictional lemonade stand.  If I tell you I have a lemonade stand that will exist for 1 year and 1 year only, and that it will make $100,000 in profits, what would you pay for it?  Neglecting inflation and the volatility of lemon prices, you would think you got a good deal if you paid less than $100,000.   Apple is worth ~ $550 billion, and investors of the stock should think that it’s a fair price to pay as long as Apple’s profits exceed $550 billion over the remaining company’s lifetime (minus cash, and the worth of their assets in a bankruptcy sale, known as book value).

Facebook has roughly 900 million users, let’s call it a billion.  At $80 billion market cap,  the company would be worth that much if it made $80 per user in profits over the lifetime.  That appears overvalued, and is why the stock has lost a quarter of its value since the IPO.  You can compare that to the price Facebook paid for Instagram’s users, and see that they only paid $29 per user, a bargain compared to Facebook stock.

So what does all this really mean?  Is Wall Street so dumb that they expect Facebook to generate $80 in profits per user from ad revenue and Farmville-esque apps?  Not exactly.  Wall Street analysts expect Facebook to come up with new ways to monetize it’s user base, increase revenue / profits to grow in to the $80 billion valuation initially placed on the company.  That is indeed the challenge that Facebook now faces.  If it does not live up to expectations, you will see Mark Zuckerberg’s wealth fade as the stock price does.

Written by thesalche

June 12, 2012 at 4:13 pm

Posted in In the News

The Bull (& Bear) Case for Apple

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Over the last 6 months there has been an insane amount of discussion around Apple’s share price, and what direction it will head next after it’s amazing run over the last several years. I’d like to throw my 2 cents in, and use Apple as an example for how you can analyze a stock without digging through financial statements.

Apple’s Products (i.e. Strengths)

iPod line

This includes iPod touch, Nano and shuffle devices. As more people adopt multi-purpose devices such as smart phones, the need for the MP3 player has decreased significantly. Although there’s a niche market for people who want the smaller Nano and shuffle devices for things like running and using as watches, the higher profit margin iPod touch is on the decline. This product isn’t going away completely in the near future, but it’s importance in Apple’s profits is becoming less.

iPhone

If you talked to me before July 2010, I probably said things like “Why do you need a smart phone?” or “Why would I pay $30/month for smart phone data when I’m paying $50/month for broadband internet” or “I’ll just share my wife’s new iPhone.” Today you won’t see me more than 10 feet away from my iPhone. The iPod helped define Apple as an electronics company instead of just a computer manufacturer, but the iPhone has turned Apple into a technology juggernaut. Sales of the iPhone continue to grow at a rapid pace. Although Google’s Android powered phones dominate market share, Apple dominates where it counts, profit share. The iPhone is a high margin product in a market that is still in its infancy. I’m convinced iPhone sales will continue to grow 15% or more a year due to 1) increased market size 2) “recurring” sales following the end of 2 year contracts with US carriers and non-US customers upgrading. The iPhone is a particularly “sticky” product when you consider the ecosystem of the App Store and iTunes. Unless users are turned off by a bad experience, they aren’t likely to switch from iOS to Android (or vice versa).

iPad

The genius of Steve Jobs and the team he assembled at Apple is that they were able to remake a product that failed miserably several years before, a product that nobody needs, and sell tens of millions of these devices. That is quite the accomplishment, and certainly has some irony when you consider how Windows stole the Mac GUI. The possibilities for this market are huge and Apple defines the market. Android tablets haven’t caught up yet and Microsofts Windows 8 strategy is confusing and has yet to play out even after 3 generations of iPads. Similar to how all MP3 players are “iPods”, all Google phones are “Droids”, all tablet computers are “iPads.” The market share and mind share Apple has developed is unparalleled. Google has stepped up to the challenge and “failed.” Don’t ask HP about the Touchpad or RIM about the Playbook. The iPad will easily make up for any lost iPod revenue, and overtake it significantly as one of Apple’s premier products.

Mac(insert name here) Computers

The more silent product that really has been getting it done at Apple are their computers. Even in the “post-PC” world, Apple is dominating all other laptop manufacturers, and even overtaking HP. In a time when computer sales are falling, Apple is posting healthy double digit growth numbers in this area. What’s amazing is the high premium Apple charges,and yet people still want to buy them. Apple has created an aura about it’s products, and it shows with the passion of their owners. The Macintosh name may not been seen around corporate America, but it will be in every hipster cafe.

Ecosystem

Apple is so busy making hand over fist amounts of money on their other products, that the single digit billion dollar revenue stream coming in from it’s ecosystem seems tiny. Products such as iTunes, the App Store, iBooks, and OS X are what help pull people in to buy Apple hardware. The management understands that users need this ecosystem and experience to continue being Apple customers, and have spent loads of cash launching services such as iCloud and it’s music match service. I imagine Apple will continue to expand its offerings in this area to keep those customers coming back for more.

Potential Headwinds

  1. New products lines for further revenue growth. Rumors have been splashed around for years about Apple creating a TV device. Their knack seems to be taking a product that has already been invented, then re-packaging it in a user friendly interface and selling at a large premium. The TV interface could certainly use a face lift, but Apple would need some agreements with cable companies to deliver a high quality product. Apple is in fine ground in the short-term 2 to 3 years, but will need to develop other products to sustain it’s high growth rate. Their new CEO, Tim Cook, is an Operations guy. You can bet he’ll keep costs in check and improve the supply chain, but he will be relying on the team Steve Jobs grew to develop the next big Apple product.
  2. Cell phone carriers resisting subsidizing future smart phone devices. There have been reports that US carriers aren’t happy with paying for 2/3 of your smart phone and getting that money back over 2 years. I dismiss those, as moves by AT&T and Verizon show they have more interest in raising subscriber charges instead. Additionally, the two carriers would have to make this move nearly in sync, otherwise the carrier reducing subsidies would run a large risk of alienating customers and driving them away.
  3. What to do with all that cash? Apple announced a dividend and share buyback program. These two are decent ways to return value to shareholders. The problem with a dividend is the double taxation, so it potentially returns less shareholder value as compared to developing a new product. Share buybacks are nice, but they are also a way for management to pay themselves back for stock options and companies tend to do them at times when their company is fairly or over-valued, rather than undervalued. This is a smarter use of capital compared to what Peter Lynch refers to as “diworseifications,” that is, acquisitions that are overpriced and don’t support the core business. That being said, Apple can afford to buy several large companies. Names like Netflix or Twitter have been thrown out there. I don’t see them buying a movie or music studio, as content creation is something Apple leaves up to its users.
  4. Law of large numbers. Apple’s market capitalization is around $550-$600 billion depending on where their stock is. It is the largest company in the world by that metric. The largest company ever was Microsoft at $619 billion in 1999. It’s true that once companies grow to a certain size, their markets become saturated and they run the risk of anti-trust litigation if they grow too much. However, if I gave an analyst a copy of Apple’s financials and divided all the revenue, profits, etc by 100, they would probably value the company with a Price/Earnings ratio closer to 30-50 range. Apple trades around 15-20 P/E.

Conclusion:

Apple is a strong brand with high quality products that sell at high margins to millions of people. Those people love their Apple products and continue to use them for the ecosystem and experience that Apple provides. The only market Apple dominates in right now is tablet computing, which is in its infancy. There’s no reason why Apple can’t continue to growth earnings at 20-30% for the next few years. That undervalues the stock at its sub 20 P/E ratio, and puts it on track to be the biggest company ever. Headwinds against the company exist, but they aren’t enough to put the stock in a negative growth or even non-double digit growth in the near future.

Written by thesalche

April 18, 2012 at 3:19 pm

Posted in Opinions, Stock Picks

What’s in your Portfolio?

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In my blogging break, I got back in to the market late in 2011. Here are the stocks in my portfolio, and a summary of why I picked them.

Fossil (FOSL)

A solid retailer on the rise. Take a look at their annual income statement on Google Finance, and you will see nice year over year increases in income. Fossil is getting it done in the US, and overseas. They have expanded their product line from watches to include leather goods, purses, etc. Fossil is not just in the jewelry section at large department stores, they have several of their own retail locations now.  As with other retail stocks in a similar situation (Coach, Tiffany’s, etc), international is a big part of the story here.  I bought in at $99 in October, and the price has been hovering around $130 for the last month or so.  I’m not sure how much more upside the stock has, and it will probably be the first one I sell if the market gets bad, although I’d prefer to hold for a year for the reduced capital gains tax rate.

Lululemon (LULU)

Unlike my initial reaction, not related to Pokemon. It’s pronounced lu-lu-lemon, and it’s a Canadian Yoga / fitness clothing retailer. This is much more of a high-flying, growth stock (compared to Fossil). They sell athletic clothing primarily for women. Think yoga and running pants that can double as casual dress for the more affluent. They have a small number of stores (150), but their same store sales growth and sales per square foot numbers are off the charts. That helps justify the high Price/Earnings ratio of the stock. They have plenty of room to grow in North America, as well as increasing their online and international presence.  The stock is priced for perfection, so the short-term volatility is high.  The nice thing about this “fashion” stock is that it has a tangible benefit for women, it makes their butt look better.  It’s very important to research your stocks!  I’ve got a short term holding in LULU at $57.50 with the stock at $74 now.

IPG Photonics (IPGP)

These guys make lasers to put on frickin’ shark heads! Okay, lasers for manufacturing purposes, not as exciting, but more profitable and less evil. I can’t say I know a lot about the business, but I’ve read a good number of recommendations at TheMotleyFool, which sold me on the growth potential of the stock.  Their financials show significant growth rates in the 25%+ range, and the stock is trading well below it’s historical P/E ratio.  This stock is a macro-economy type play, so the risks related to this stock are global recessions induced from eurozone debt trouble / whatever the guys on Wall Street are cooking up next.  Since I bought the stock at $48 in October, it’s hit lows around $34 and highs around $60, while earlier in 2011 it was trading around $70.

Healthstream (HSTM)

I’ve mentioned this company several times in the past, in fact I should have owned it from my first mention as the stock has nearly tripled in that time frame. The company continues to post impressive subscriber increases, revenue / profit growth, etc. There are some rumors of a potential buy-out from a larger IT company such as Cisco, which at a minimum gets more buyers of the stock interested and is a nice icing on the cake. I truly believe this stock has the potential to be my first 10-bagger (bought it at around $400 million market cap, $4 billion may be achievable over a long period of time). What’s attractive about this business is an increase in the number of people employed by the health care sector with an aging population, more technologies and treatment methods becoming available and the training required for those health care professionals (that’s what HSTM does!). A subscription based business model gives more earnings stability, and opportunities for higher revenue without increased overhead costs (kind of like same store sales growth in retail).

The first time I bought Healthstream it was at $6.45.  If I had of been smarter, and not panicked in early 2011 after Fukishima, that stock would be worth four times what I initially purchased it for.  I bought some shares in October (seeing a pattern here?) at $17.20, while it trades today at $25.97 for a huge 50% gain.  I’m confident this stock will become my first multi-bagger, and I don’t play on selling my shares in Healthstream anytime soon.

3D Systems (DDD)

The ticker symbol of this company is quite tantilizing, but it is also in an interesting business. The company manufactures 3D printers and the “ink” for those printers. This has applications for prototyping, which many high flying tech companies are interested in, as well as a consumer based business. At the Consumer Electronics Show 3D introduced cubify, a consumer product with a $1000 price point. This has a lot of interesting implications, including a community type model where some people design 3D models in CAD software, then sell those designs to the masses who go to their 3D printer and print things out such as toys, smartphone cases, etc. As with the 2D printer market, the profits here come from recurring revenues on the “ink.”  This space is heating up and one of it’s competitors Stratasys (SSYS) is getting attention.  There’s plenty of room for both companies to become multi-baggers.  I like the possibilities of consumer facing devices over high-tech prototyping.  3D printing is much further away from being a primary method of manufacturing than it is from a consumer product for the 1%.  This has been a solid performer, gaining 30% since my purchase in February.

ProShares Ultra MidCap400 (MVV)

Not a stock, but an Exchange Traded Fund (ETF) that invests in the S&P 400 mid market capitalization companies. The bonus here is the 200% leverage, which allows one to double profits/losses. It’s a nice alternative to a vanilla index fund for an investor willing to take on more risk.  It’s up around 25% since I purchased shares in October.

Written by thesalche

January 29, 2012 at 9:07 am

Posted in Stock Picks

One Up On Wall Street

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I have re-energized my interest in picking stocks after reading Peter Lynch’s “One Up on Wall Street.”  Peter lynch is a famous mutual fund manager, who ran Fidelity’s Magellan Fund, which handily beat the market over many years.  Lynch has a fascination with scuttlebutt or on the ground product research through word of mouth.  Lynch gives the example of L’eggs, a popular Hanes product, which led the stock price soaring.  When I think about this idea, stocks such as Apple, Coinstar (i.e. Redbox), Netflix, Ford, Chipotle and Panera Bread come to mind as trends that were obvious based on the products I buy and people I know buy. It’s somewhat frustrating to think that I watched the stock market crash in 2008 when I started working, and didn’t think that an investing opportunity existed when the market bottomed out in March 2009.

Lynch points out that companies with recurring revenue models have less volatility and have growth potential.  The classic example is Gillette’s razor and razor blades model.  The converse would be a company like Sony, who sells you a big screen TV and then the relationship essentially ends until your TV breaks or you want to upgrade.

Lynch advocates acting as a Wall Street outsider, and ignoring the financial news as best as possible.  It has been interesting to watch the news about an impending economic collapse in Europe starting in July of last year, and yet the Euro still exists six months later.  Somebody who had not been paying attention to the financial media would recognize that US stock fundamentals continued to get better through the 3rd and 4th quarter 2011, and as a result the market eventually caught up to reach pre-July “corrrection” levels.

This hardly covers the nearly 300 pages of investing wisdom and entertainment Peter Lynch provides, I would recommend his book to anybody looking into investing for the long-term.

Written by thesalche

January 15, 2012 at 1:02 pm

Posted in Opinions

Stock Pick #1: Amazon

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I admitted my incorrect observations on the overall market trend in my last post, and since then I have picked a new batch of 1K Challenge Stocks.  I want to start off with an old pick that I’ve re-invested in.

I documented some reasons of my Amazon pick in an early post.  Those reasons still apply (leader in online retailers, expansion in digital distribution, Kindle sales).  The stock price has been flat since the beginning of the year.  It was hurt slightly by 4Q earnings, but has bounced back since announcing the Amazon Cloud music player and launching it’s Android App Store.  The tech rumor mill is spinning for Samsung creating an Amazon Kindle Tablet.  This move makes sense as it puts a nice bow on the digital content distribution Amazon has been looking to set up.  They have introduced streaming video for its Prime members (Netflix competitor), have a large digital music distribution and sell TV shows / movies through downloads.

One common downfall for companies as they grow from the mid-cap to large-cap state is that they end up making poor decisions with their cash.  Think of Enron Broadband services, or Cisco’s purchase and sale of Flip.  This is why Wall Street wants a company like Apple who has $40+ billion on their balance sheet to provide a dividend rather than purchase a multi-billion dollar company.  In Amazon’s case, investing in a tablet device has good synergy with the rest of its business.  The only downside is that the Android platform is an “open source” platform and a Kindle Tablet would most likely force customers to buy from the Amazon Appstore and wouldn’t allow access to the eventual Google Music service.  Amazon would also be able to provide the tablet at a cheaper price (less than $500) because their largest source of profits would be the sale of its digital content.

The biggest threat to the company is the eventual tax code change that will require Amazon to charge some form of sales tax.  Right now, Amazon customers enjoy no sales tax, which is a big discount in itself.  Amazon has been becoming more competitive with pricing in general, so it will likely still have a discount compared to B&M big box stores even if customers pay sales tax.  Also the convenience factor of online shopping in a $5/gallon gas world and the product review system give Amazon a competitive advantage over its B&M cousins.

The Street also ended up responding positively to Amazons 1Q11 earnings miss.  The stock was forgiven because Amazon is using its cash flow to re-invest in the business.

I bought 1 share of Amazon (AMZN) for $170.90 on 3/29/11 and the stock is up to $197.60 for a gain of 15.6%.  So far so good!

Written by thesalche

May 7, 2011 at 9:44 am

Posted in Stock Picks

Maybe I Was Wrong (Overall Anyways)

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It takes a man to admit he was wrong(ish) about something.  In my previous post I declared that we were in a bigger market correction.  Then I went on vacation for a week and the market had popped back from its roughly 6% drop to rising above it’s price when I left.  Hmm…  I suppose I shouldn’t make bold predictions such as that.  Although the overall market has done well, the 1K challenge stocks would have taken a beating had I held on to them until today.  Let’s go to the tables.

So we can see that when I sold all my stocks, I ended up with a nice little profit.  It’s important to note this did not including trading fees / taxes that I will have to pay on these earnings.  Now let’s take a look at how things could have looked …

Now, we can see several of those companies got SLAMMED, while the ones that gained were relatively modest.  Here’s why:

Advanced Battery Technologies (ABAT) – Appears to be a case of fraud occurring.  An equity research firm is filing suit against the company for misleading investors, fraudulent multi-million dollar acquisitions, etc.  Doesn’t look good for the Chinese battery maker at this time.  I’m glad I got out before today!
Cameco Corporation (CCJ) – Unless you have been living under a rock, you know there is a potential for partial core fuel melts at the Fukushima Daiichi Nuclear Power Plant.  This has had some huge impacts for stocks in the nuclear sector.  Whether the declines are fair or unfair remains to be seen.  I believe it’s a potential buying opportunity.  I would not expect the world to begin shutting down nuclear power plants, or for China and India to stop building them (although some construction has halted for the moment).  Regardless, getting out of Cameco was fortunate timing.
Urban Outfitters (URBN) – The company missed on 4th quarter earnings and the stock dropped 16% as a result.   This stock was a good idea at the time of my purchase, but the uncertainty associated with retail appears to be a tough game to play, and I don’t want in anymore.

Back to the drawing board figuring out what to do next.  I’ll be looking at a few stocks in the coming weeks, so stay tuned.

Written by thesalche

March 30, 2011 at 6:54 pm

Posted in Uncategorized

And the Bottom Drops Out

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It’s almost official. The bull run that has lasted since April 2010 (really March 2009) is in a new downward correction phase. It’s been a long time coming, and watching various news sources has been interesting. There has been a definite shift in the discourse. Discussions back in October were very bearish, believing that the market could not sustain an upward trend following the excellent performance in September. Now if you listen to people talk about the stock market, they will tell you that right now we are having a brief “pause” in the upward growth and that the stock markets are on their way to reaching new all-time highs by next year. I don’t believe it, and here’s why.

  1. The jobs market is slowing turning and US companies are doing more hiring. The unemployment rate did drop significantly in January 2011, but that appears to be due to a) more people leaving the workforce and b) population adjustments. Either way, job growth has been slow and we are far below pre-recession job levels. Jobs are a leading indicator, and I would argue the most important considering that consumer spending is 70% of US GDP. We are headed in the right direction, but the big indices are only 15% below their 2008 highs and this is not reflected in the jobs market.
  2. The housing market is in even worse shape than the jobs market. That’s okay, because housing is a lagging indicator of economic growth. People have to start getting jobs again before they can afford to buy new houses, especially with the new and reasonable demands on home buyers. What’s interesting about that Case-Shiller index I linked to, is that average home prices are still above 2004 highs, but the stock market hasn’t done much over the past decade.
  3. Uncertainty in the Middle East and oil prices. It looks like there is a huge domino effect occurring in the Middle East and Africa with the topping of dictators in Tunisia, Egypt and potentially Libya. The biggest threat in the region is Saudi Arabia, who controls significantly more oil production than the previously mentioned countries.
  4. There is some trouble in nations with the Euro currency. Ireland’s banking system required bailouts, Spain’s debt was downgraded by the credit agency Moody’s and the recession in Greece. Granted, these have all been survivable so far. But there are questions about which European nation will require the next bailout. To be fair, these bailouts are small compared to the one given to AIG in 2009. However, they are still signs of a struggling world economy.
  5. Unfortunately, Japan has a large earthquake and tsunami to deal with. More dear to my heart is the fate of the nuclear reactors in that nation. In the end, I believe any loss of life will be attributed to the hydrogen explosions and potential a few plant workers with long-term health effects (cancer). The event will be used by opponents of nuclear with the argument of “What if it had been worse?” and supporters will point out that the plant withstood conditions outside of it’s design basis. I highly doubt that China and India will halt the construciton of nuclear reactors, but the future of nuclear power in countries such as Germany, Japan and the US are questionable or at least put on hold for now.

This all being said I sold my positions at the end of February / beginning of March. I don’t plan on getting back in until the market is back on a clear uptrend, which may be weeks or months. Until then, I will find some other investing topics to talk about on my little WordPress soapbox.

Written by thesalche

March 1, 2011 at 11:18 am

Posted in Performance

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