6-Dec-02 Robert W. Baird downgrade: from Neutral to Underperform
While I don't automatically dismiss these types of calls, I do my own analysis simply because on a small growth company the analysts are so frequently wrong. I can't tell you how many people I know whose first job at a brokerage or investment bank straight out of B school was that of a junior analyst. They are almost always the ones who are put on these little companies. While they catch the obvious stuff anyone can see, like declining growth rate, rising expenses, negative cash flow, they don't have the experience one gets from having watched a lot of other companies that went from micro cap to large cap. Basically they consider a company like this to be high risk simply because it doesn't have enough quarters of results to be reasonably certain about it's future. Last quarter the three analysts following this company were completely off on the earnings (guessing 6 cents when it came in at 12) while my stupid little spread sheet had it down to the penny.
it's sector carries an average PE of 37.28, it's industry sector, 24.14
Yup and there is a really good reason for that. Most in the sector are experiencing flat to negative growth. Even a PE half of that is too high for most of them. WEBX has a PE of 100 based on past earnings, but it has a PE of 30 based on '03 earnings and a history of nine quarters of making their targets. Needless to say, you are right, the high PE means it's selling at a premium and that premium is dependent on that high growth not faltering. Remove the growth premium and it's cut in half. If growth continues at the projected rate then it's worth 26 in '03, That's 40% higher from here.
Also, I'm sure you know that if inflation rears it's head that growth is also worth less. One of the things everyone forgets when they keep calling for low PEs to make a bottom is that future earnings are adjusted for inflation. A PE of 30 in a high inflation environment like 1982 does not carry the same real return potential as a PE of 30 in 2 percent inflation. Primarily because future earning always have to be discounted to the inflation rate the same way bond yields follow inflation expectations.
If you've followed a lot of growth companies you'd know that they always sell at a premium. Over and over again you see people say they won't buy this is or that because it's too expensive yet as long as they remain growth companies they remain over valued. Growth sells at a premium because people will almost always pay a premium (thus accepting a lower return) for less risk in expected results. If growth falters or flattens and that premium evaporates as we saw with the high growth techs that turned into slow growers.
I'd pass on it at this price, imo, but nice pull back today -8.2%
One could still say the risk reward would be considerably better at say 13-15, not only because it makes that possible upside gain to 26 look better but a buy at that level significantly reduces the downside risk of 7 to 9. Looking at the historical volatility it's an even bet that the price would fluctuate down to that buy point, especially if this pull back accelerates. This is why if you see something "over valued" it still pays to investigate thoroughly. I put companies like that on my wish list and because I always hold a lot of cash I can deploy it in the event that opportunity presents itself. If you don't know what it's worth you don't have sufficient conviction to go in and buy when the opportunity presents itself. It's easy to get scared off by the price action. Price is almost always wrong in the short term but it's deadly accurate over long time frames.
Right now I'm seeing so many people who have stopped even looking at companies because they've become overly conditioned by the downside and there is a lot of fear, a lot of cynicism. It's sad because amongst the rubble there are always good stories. When everything looks terrible is when you actually have an opportunity to make some real money. Right now people are so negative that even a company with great growth and strong price appreciation is seen not as a potential investment but as something that hasn't gone down yet or as something that perhaps has been fraudulent in their reporting. This is the environment where a good stock picker with the ability to cut through BS can really excel. |
