To all: Congratulations on posts well-done in my absence. Most of you were cool and remained strong in the face of the recent selloff. That's something you can be proud of.
WIND's stock price has been under pressure because of: (1) Barron's High-Flying Stocks article, and/or (2) fear of a bad quarter out of continued sympathy with INTS and MWAR, and/or (3) concern that Microsoft is awakening to the embedded systems market and will squash the small RTOS players, and/or (4) plain old momentum players.
Scratch (2) above as a concern. WIND just announced the quarter and it was absolutely wonderful, beating all analysts estimates, with earnings up 116% year-on-year and EPS up 77%. For the record, my estimates overstated revenues by $280,000 on an actual base of $19,800,000. I hit the earnings estimate exactly at $.23, which is why I indicated earlier the range from 21 to 23 cents. In short, WIND had a dynamite quarter and remains firmly on tract to become a great growth company. As someone once elaborated on the statement that Unix is the best operating system in the world: "Actually, it is a lot better than that." Well, WIND is a lot better than just a great growth company.
Scratch (1) above as a concern. After reviewing all the posts during my absence, it is clear that we are still being haunted by Benjamin Graham's ghost equation that asserts that the intrinsic value of stock is approximately equal to Earnings times sustainable Growth Rate; or that the PE ratio of a stock should be no more than its sustainable growth rate. I have challenged this misleading rule-of-thumb in the past, but it keeps creeping back in (thanks to Barrons and interlopers) and needs another stake in the heart.
Benjamin Graham led the post-1929-crash analysts in rejecting a notion put forward in 1924 by E. L. Smith that future growth should in included in pricing stocks? Prior to the twenties, equity investments were extremely volatile and so speculative that investors never formally considered growth. To even think about growth was tantamount to consorting with the devil of speculation, and in those unregulated hay days, the balance sheet alone challenged investors to their limits.
So isn't it ironic that "Value Investing Graham" produced the most commonly used formula for growth investing? Actually, Graham never intended the formula to be used for growth stocks; he simply conceded that growth can sometimes be assumed up to the 7% to 10% range, the consequences of which he attempted to capture in his formula. Notice that 7% to 10% is about the long-term growth rate of the market, and fits comfortably into linear thinking about expected outcomes. Incidentally, in those days the pricing model for equities consisted entirely of the present value of the future dividend stream. Even today, students of finance are taught to discount expected dividends - while confusingly also being introduced to the notion of earnings and free-cash flow.
Warren Buffet makes it clear that the equity investor is part owner of the company, and values his/her investment strictly in terms of per-share dividends PLUS free-cash flow after dividends. There are weighty issues regarding the difference between earnings and free-cash flow, but the difference usually is not at issue for software companies. (Sometimes even with software companies this difference can be pivotal to the market, and often used by short-sellers to tank a stock. An example is the recent controversy that arose over SYSF's treatment of certain revenues and R&D expenditures.)
It makes no sense whatsoever to say that a stock is a good buy when its PE is no greater than its sustainable growth rate. Trailing PE has nothing to do with the intrinsic value of a stock. WIND was undervalued when at its recent peak of over $53. The only risk in buying the stock at today's price is that you might be put in jail for stealing. Frankly, I am embarrassed that the market has reacted as it has recently.
I am convinced that you can scratch (3) above as a concern, but this is just my opinion. If this is the item that is of most concern to the market (brought to light by the up-coming key-note speech by a minion from Microsoft at the Embedded Systems Conference East - as duly noted by David Stuart) then WIND's stock price will not rebound and stay up significantly over the next few days. If this item is not a primary item of concern to the market, then the market owes WIND an apology - in the form of working its way back up forthwith.
Since the market will do what it wants to do, I say, "I just don't care". I own part of a great company, and if the market is too dumb to appreciate it now, the hell with it. If anything, periodic huge but silly paper loses is good for character, and absolutely essential to experience personally from time to time. You cannot be a disciplined investor if you cannot handle the heat, and you can never know if you can handle the heat unless you experience it.
I leave as an exercise for the reader the proof that WIND is undervalued at the current price, in the forties, fifties, etc. HINT: extrapolate earnings out a few years, apply a minimal PE ratio to the resulting earnings, and calculate the present value of the result. Never extrapolate more than about five years, no matter what you think about the company (WIND being the only possible exception.) An alternative is to calculate the earnings growth rate implied by the current price of the stock, and then ask yourself whether or not the implied rate will safely be achieved.
The final exercise is to prove to yourself that buying a high tech stock with a PE LESS than the expected growth rate generally is exceedingly risky. HINT: the gigantic inconsistency between the market price and its calculated value always is because the market doesn't believe the analysts' growth rates. The market prices stocks on the basis of earnings growth. If the price is low relative to analyst growth estimates, then the market is simply saying estimated growth rates are too high. If the price appears high relative to trailing earnings, the market is simply saying earnings will be fast growing. Your job is to understand what earnings growth is likely and buy when the likely growth significantly exceeds the market's estimate and you know you are right. This has nothing to do with trailing PE ratios.
Scratch (4) above as a concern. If it is a market sell-off by momentum players, then it really doesn't matter.
Allen |
