| Brocade Communications (BRCD) 91 13/16: If nothing else, you have to give Barron's credit for one thing: consistency. No publication more consistently and predictably questions the valuations of high growth, high P/E stocks than Barron's. They're starting 2001 the same way by questioning Brocade's 144 P/E on FY01 earnings. The article doesn't spend much time addressing the real issue regarding Brocade's valuation, which is whether fibre channel will continue to be the protocol of choice in the SAN, and if it doesn't, whether Brocade can retain its dominant position in the SAN switch market. Instead, this is pretty much a straight valuation question. Is a 144 P/E too much? Unfortunately, there is not much enlightenment here either. The article does try to portray the issue fairly, even quoting a bullish analyst who offers the rhetorical question of whether you want to buy a 100 P/E stock with 100% 12-month growth or a 35 P/E stock with 10% growth. This is one of those arguments that you're supposed to assume is correct without doing the math. But if you do the math, you find that there's not enough information to know the answer. At the end of one year, the high growth stock has a 50 P/E and the lower growth stock has a 32 P/E. So the lower growth stock is more attractive if the growth rates are both 10% after the first year. This is a roundabout way of saying that whether or not Brocade or any high growth stock is fairly valued is not an issue of the coming year's growth rate -- it's the long term growth rate. And that's where Brocade's valuation clearly becomes a fibre channel issue. Brocade continues to dispute the notion that this is an issue, arguing in the Barron's article that it's still 3-6 years before there will be a viable option and implying that Brocade can also dominate that option, should it become a reality. While we have made many positive comments about Brocade in the past, we became cautious as the valuation exploded and the price hit the 120 area (split-adjusted) back in October. The reason is that while Brocade may well dominate any future SAN protocol in the same way that it has dominated fibre channel, the probabilities of such domination are clearly reduced. It's the same end-market but a different underlying technology if the protocol changes. Brocade's valuation leaves little room for error in this battle, which is why we have shied away. But that protocol battle is the key issue -- not the growth rate in the next 12 months. Brocade is a company with great prospects, but either the valuation must come down to reflect the threat to fibre channel, or fibre channel must clearly win the protocol battle. - Greg Jones, Briefing.com |
