A Gentleman's Bet Against This Year's Best Stocks: John Dorfman
By John Dorfman
Boston, July 12 (Bloomberg) -- Investing on raw momentum -- buying stocks that are going up, just because they are going up - - used to be considered as unsophisticated as picking your nose in public.
Now, many people consider it a legitimate school of investing.
Investment chat rooms encourage people to jump on fast- moving bandwagons. Analysts offer technical-sounding terms such as ``relative strength'' to dignify the practice of buying what's hot.
As a way of dramatizing my disagreement with the ``momentum'' crowd, I hereby make an open, gentleman's wager. I bet that the 10 leading stocks year-to-date can't beat the ``Smudge Portfolio'' that I selected absolutely at random.
The Leader Board consists of the 10 stocks up the most through Friday, among stocks with a market value of $1 billion or more.
The Smudge Portfolio has humbler origins. I selected it by closing my eyes and making felt-tipped pen marks on the newspaper stock listings.
Nothing But Nasdaq
The Smudge Portfolio contains five New York Stock Exchange stocks and five Nasdaq Stock Market stocks. By contrast, the Leader Board contains nothing but Nasdaq issues.
The period for this gentleman's bet is from the market close on Friday through the close on Friday July 6, 2001. I will report the results in this column next July.
Here is the Leader Board. Tollgrade Communications Inc. is up 654 percent, Rambus Inc. is up 499 percent, Newport Corp. 473 percent, GlobeSpan Inc. 451 percent, Aeroflex Inc. 358 percent, Zygo Corp. 354 percent, Power-One Inc. 279 percent, Elantec Semiconductor Inc. 275 percent, Vertex Pharmaceuticals Inc. 253 percent and Cor Therapeutics Inc. 245 percent.
Tollgrade, based in Cheswick, Pennsylvania, makes equipment that phone companies can use to diagnose problems in telephone lines remotely. Its equipment can be used for both copper and fiber-optic phone lines.
Shares in Tollgrade were first sold to the public in December 1995. The company has earned a profit, generally a rising profit, in every quarter since. Earnings have grown at an average compound annual pace of 38 percent the past five years, and analysts expect them to continue growing at a 20 percent clip.
Is P/E Justified?
That's much to Tollgrade's credit, but I wonder whether it justifies a stock price that is 114 times recent earnings and 23 times book value (corporate net worth per share).
And Tollgrade is by no means the most expensive stock in this group. Rambus, a Mountain View, California, company that designs memory chips that help speed personal computers and other devices, sells for 940 times recent earnings and 135 times book value.
Seven of the 10 leaders sell for 100 times earnings or more. Six of them sell for 20 times book value or more.
Three of the 10 leaders don't have a price/earnings ratio because they posted a loss in the most recent four-quarter period. GlobeSpan, of Red Bank, New Jersey, develops advanced digital subscriber line (DSL) integrated circuits. It went public about a year ago and was profitable in the past two quarters but not on a trailing 12-month basis.
Vertex Pharmaceuticals went public back in 1991. It has reported a loss in 27 of the past 29 quarters but has said it expects to report a profit of 40 to 50 cents a share for the second quarter. The Cambridge, Massachusetts, company is working on drugs to combat AIDS and other viral diseases.
Fighting Cardiovascular Disease
Cor Therapeutics, based in South San Francisco, California, also went public in 1991. It has posted a profit in three of the past 29 quarters, one more than Vertex. It is developing drugs to prevent or cure severe cardiovascular diseases. Its revenue in the past four quarters has totaled $67.1 million but the stock market values the company at $2.37 billion.
Most of the Leader Board stocks fall into three fields: communications, the Internet and biotechnology. Those are all exciting, promising, wonderful fields. But for most of these companies, I believe the current stock price already reflects all the success that is to come, and then some.
Now let's turn to the other team in the competition -- the Smudge Portfolio. The five New York Stock Exchange stocks I picked by closing my eyes and stabbing with a felt pen are:
-- All American Term Trust, a closed-end bond fund based in New York.
-- Canadian National Railway Co., based in Montreal, which serves parts of Canada and the U.S.
-- Deutsche Telekom AG American depositary receipts, which represent shares in the telephone company based in Bonn, Germany.
-- Great Northern Iron Ore Properties, based in St. Paul Minnesota, which leases its land for mining (mostly taconite) and collects royalties.
-- Montana Power Co., a Butte, Montana, utility that sells electricity, natural gas and communications services.
The five Nasdaq stocks in the Smudge Portfolio are:
-- Greater Bay Bancorp, a bank holding company based in Palo Alto, California, serving the Silicon Valley area.
-- Keynote Systems Inc., of San Mateo, California, which provides Internet performance measurement and diagnostic services for electronic commerce.
-- Next Level Communications Inc., of Rohnert Park, California, which provides broadband communications systems using existing copper wire networks.
-- Republic Security Financial Corp., a small bank holding company in West Palm Beach, Florida.
-- Time Warner Telecom Inc., a fiber-optic telecommunications company based in Littleton, Colorado.
The Smudge Portfolio contains several stocks more expensive than I would actually buy for myself or for clients. However, it does contain a sprinkling of cheap stocks, such as Canadian National Railway and Great Northern Iron Ore.
On the whole, I think it suffers less from investors' over- enthusiasm than does the Leader Board. I'm reasonably confident the Smudge Portfolio will win this wager.
(John Dorfman can be reached at jdorfman@bloomberg.net or Dorfman Investments, 101 Federal Street, Suite 1900, Boston, Massachusetts 02110.) |
