Stocks in single digits grab me as much as $500-plus icons like Apple and Google. Owning a ragamuffin is the ultimate existential act. You are what you own, and at 4 pm when the animals go back inside their cages, you can count your money faster than King Midas. Maybe there were futures in wheat and gold in Midas’s time, but little else.
Image via CrunchBase
My single digit ragamuffins include Sirius XM Radio and Bank of America. What I find so curious, even ironic, is that security analysts can’t even analyze (or prophesize) mega cap properties like Apple and Google. Apple now ticking at plus $400 billion was a ragamuffin a decade ago.
Even IBM and ExxonMobil elude so-called sharp penciled analysts and money managers. Nobody had factored in ExxonMobil’s drastic shrinkage in downstream earnings in the fourth quarter. As for IBM, the consensus waits impatiently for IBM to roll over and play dead. It ain’t happening.
Actually, few “investable” stocks still sell in the teens. Morgan Stanley and Cisco border the teens decile, but there is Ford and there was General Motors. General Electric is dangerously close to twenty bucks. My Xstrata on its takeover by Glencore goes from teens to maybe over $20. I remember Walt Disney at the bottom of the market in ’09 sold at $14, now $41 and thriving. Fundamental properties can get trashed, too.
Not that I’m looking for penny stocks which normally capitalize with 500 million shares or more and no fundamentals to speak of – maybe some leased acreage in Wyoming. What I’m focused on are mispriced stocks and mispriced market sectors. They’re all over the lot starting in technology, with a capital “A” as in Apple.
If you believe as I do that leveraged earnings power is the bold theme, consider four sectors now outperforming – technology, financials, materials and industrials. Reason for the outperformance is nobody can get his hands around the fundamentals and model major properties like Apple, Google, ExxonMobil, Citigroup, Goldman Sachs – even U.S. Steel and DuPont, let alone Freeport McMoRan and General Motors.
They’re gut plays. Security analysts don’t get paid to make gut plays, only feisty money managers. Analysts frequently model companies employing as many as 25 variables. If 100 analysts are within a penny of each others’ earnings projections (Coca-Cola) the stock is efficiently priced and only levitates with earnings growth.
In bear markets, many of us hide in stocks like Coca-Cola where your numbers can’t be off more than a penny or two. Same goes for Merck and United Technology because management’s “guidance” is hands on and usually accurate.
As far back as I can remember Apple’s management played fast and loose with the Street. A busload of analysts, regularly manipulated, missed quarterly projections by as much as 50 percent (the December period.) Apple low balls its numbers and analysts, who are natural cowards, hesitate to dash far ahead of the pack.
How can anyone, including management, forecast quarterly demand for iPhones and iPads? It’s even difficult to project where we are in terms of market saturation. Why can’t everyone own 2 smart phones and tablets? I do.
When the cellular telephony sector took off industry pundits projected the sector would reach an 8 percent saturation level in 5 years. Currently, we’re approaching 100 percent and beyond.
The same goes for Google and internet advertising. The Street projected internet share of advertising would move from 1 percent to maybe 5 percent over 5 years. This kind of low balling made Google a great stock. Internet advertising is at a mid-teens market share.
Comparisons with Facebook in terms of “going public” initial valuation favor Google which currently sells at a mid-teens price-earnings ratio. This is comparable with many media houses in the entertainment sector, Disney, for example.
Google’s valuation in the 2004 underwriting was pegged at 7.5 times revenues, 24 times EBITDA and 58 times earnings. Underwriters and investment bankers get paid to squeeze every last buck from the public’s purse.
Facebook actually breaks the bank, coming at 24 times revenues, 45 times EBITDA and 90 times earnings. Even if Facebook’s earnings double next year this is pricey merchandise and I’ll pass it by, maybe even buy more Google. After all, advertising is cyclical, governed by GDP momentum or lack of same. Facebook’s valuation can only be rationalized if you believe mobile ad spending mushrooms 50 percent a year for the next 5 years.
Back to Apple. The stock broke out last week coincidentally with the release of a serious, relatively lengthy but sharply focussed research report by Charlie Wolf of Needham. Charlie is the only analyst I’ve ever talked to about Apple, once, two years ago, on Steve Job’s longevity. Charlie’s at $620 from $540 but this ain’t really relevant because nobody’s valuation model has ever worked. Three years ago Apple ticked at par. Nobody ever rants a stock is going to the moon. Periodically, you update numbers, quarterly if necessary.
Charlie believes there’s a halo effect on Macintosh computer sales from iPad and iPhone market penetration. I discount this impact but agree that Apple today is more iPhone vulnerable than iPad in terms of approaching market saturation. The iPod did add luster to iMac sales. At that juncture, I bought Apple, reasoning that the iPod would put away the Sony Walkman which had a worldwide footprint of 500 million users. It was 2001 and Apple ticked in the thirties shortly after the internet bubble imploded.
My dream is that ancillary recurrent income from internet advertising and thousands of apps evolve into a major profit segment in coming years. Software and peripherals are probably no more than 5 percent of earnings today. There are over 170,000 apps written for the iPad, alone.
Is Apple a more dangerous stock to own at 11 times earnings than any other piece of paper with a comparable value tag? Pressing this valuation issue, is Google likely to revert to Apple’s multiplier or vice versa? I say versa. Either Apple is too cheap or Google is overpriced. Deep basic, neither stock is overpriced to the market considering its free cash flow multiplier and liquid assets.
Take Cisco. Sells at 11 times earnings, no net debt, annually buys back 5 percent of its outstanding stock, holds a boodle of liquid assets (alas, most of it overseas) but is finally controlling its expense lines and growing revenues near 10 percent per annum. A nice profile.
The market’s insanity is paying up for mediocre industrial properties like U.S. Steel on what they possibly could earn in 2013 if everything comes up roses and daffodils. But, everything doesn’t ever go right for U.S. Steel. Its yearend quarterly report was a mess. Despite the recovering GDP setting, U.S. Steel lost hundreds of millions. They dropped serious money in 2010 as well. Its flat rolled product segment remains in negative territory.
Big Steel is shedding liquidity as well. Capital expenditures exceed depreciation and they’re down to $408 million in cash. In a bad setting U.S. Steel burns cash fast. What caught my eye was a huge write-down on sale of U.S. Steel Serbia to the Republic of Serbia for a nominal sum. One dollar? A write-off is coming for over $400 million on their plant account of $6.6 billion. U.S. Steel has more debt than equity.
As a stock U.S. Steel bottomed at $18 and now sells near $30. When I checked analysts’ projections the best I could come up with is $3 a share in 2013 - if all goes well. Apple earns $51 a share with $150 a share in cash on the balance sheet if all goes well.
Which one would you rather own? The breakout in Apple adumbrates sharper focus on growth stocks, particularly technology. Recovery in capital goods properties is overdone, energy is just fairly priced, consumer non-durables as in PepsiCo, are boring and the financials…. well the financials remain inscrutable.
If you believe as I do that Wall Street experiences a better year in underwriting, investment banking and trading you hang onto Bank of America et al., but gimme growth at 10 times anytime, anyplace bar nothing.
What in the world was U.S. Steel doing in Serbia?
Martin T. Sosnoff is chairman and founder of Atalanta Sosnoff Capital, LLC, a private investment management company with $8 billion in assets under management. Sosnoff has published two books about his experiences on Wall Street, Humble on Wall Street and Silent Investor, Silent Loser. He was a columnist for many years at Forbes Magazine and for three years at The New York Post. Sosnoff owns personally and / or Atalanta Sosnoff Capital owns for clients the following investments cited in this commentary: Sirius XM Radio, Apple, Google, Morgan Stanley, Cisco, Ford, General Motors, General Electric, Xstrata, Walt Disney, ExxonMobil, Citigroup, Goldman Sachs, DuPont, Merck, United Technologies, Cisco and Bank of America.
Martin Sosnoff: mts@atalantasosnoff.com
