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Strategies & Market Trends : Gorilla and King Portfolio Candidates -- Ignore unavailable to you. Want to Upgrade?

To: Mike Buckley who wrote (7428)	10/4/1999 12:23:00 AM
From: Mike Buckley	Read Replies (2) \| Respond to of 54805

John, If I didn't bore you with that previous lengthy post, this one will definitely put you to sleep. :) Cha2, close your eyes. This one is all numbers! :) As I mentioned, I ran valuations on Gemstar tonight using three different metrics, all of them traditional. PE to Growth Gemstar's trailing PE (I know a lot of people around here don't like that metric.) is about 3 times its expected growth through 2001 consensus estimates and through the Stephens 2004 estimates. Remember, though, that's applying a traditional metric to a potential gorilla, which all of us know needs to be tweaked. Three times the growth rate is rich for me, even for gorillas, but it's not astronomical for a company whose product is so early in the adotion life cycle. (I much prefer that this size company have a multiple that is no more than twice the expected growth.) Even if the current price is too rich, it doesn't mean we won't enjoy market-crunching returns. Also, the expected growth rates do NOT have increased profits built into their model should the litigation be resolved in Gemstar's favor. If you and I were to factor in increased profit assumptions, the apparent premium using this traditional PE metric would be lower. Discounted Cash Flow I used the Stephens discounted cash flow model but altered it in a significant way. Where they used a 13% discount rate, I used 20%. Some people will be shocked to learn that I used such a high rate but I'll defer an explanation, if it's needed, for another time. Using a 20% discount rate and all of Stephens's other assumptions, Gemstar's fair value at the end of FY 2000, 01 and 02 is $59, $70 and $83, respectively. Again, that's using a traditional metric, a no-no for gorilla and gorilla candidates. Those values also don't include any upward revisions relating to a happy settlement of litigation. And anyone aware of the reasons supporting the choice of a discount rate knows that a 20% rate builds in one heck of a lot of margin for error. Even so, notice the $83 fair value in 2002. That's what the stock is today. It's not at all unusual that a gorilla, especially an enabling gorilla, is priced three years ahead of what traditional metrics would dictate. Back to a more typical discount rate (typical considering the market's perception of risk), the Stephens cash flow model was written in June. Based on their assumptions using the 13% rate, the stock today is where they pegged fair value for the end of 2001. That's two years from now. Price to Sales This is the least defensible of all quantifiable metrics in my opinion. Still, it's shocking for me to see that the market cap is about 16 times Stephens's estimated revenue in 2004. Wow! That IS rich by any standard and is the scariest of the three metrics I used. Final Thoughts In summary, I see Gemstar as being somewhat overvalued using the PE-to-growth metric and being fairly valued using the cash flow discounted at 20%. Those two metrics tell me that the stock isn't undervalued but I also don't consider it horribly overvalued. I don't know what to think of the PSR. Cisco's trailing PSR is less than 20, nut much more than Gemstar's 2004 PSR. If that doesn't give an investor pause, I'm not sure than any valuation will, gorilla or no gorilla. Because I already own a reasonable position in the Gem, I'm not going to stretch so far as to pay for that PSR. That's a metric a huge portion of the investment community pays attention to, so perception will surely come into play. Someone tell Cha2 it's now okay to open his eyes. :) --Mike Buckley