Cramer on BRCD
Brocade, the Ultimate Tell of This Tape
By James J. Cramer
2/26/01 8:35 AM ET
Last week, when Brocade (BRCD:Nasdaq - news - boards) broke, we saw the final round of the "one market/one multiple" thesis. The importance of this crushing of Brocade can't be overlooked by either investors or traders because the company represents the quintessential tech stock in this environment. It is, alas, the "control," if science were at all involved in stock-picking. (My regular readers know that psychology plays a much bigger role, but the pros never want to admit that because it's too "soft.") Put simply, Brocade has the best management I've seen in tech. Greg Reyes -- a fearsome, tough, honest competitor -- believes in two things: making the most money for shareholders and destroying the competition. He's the greater fighter in your corner as a shareholder, exactly who you want duking it out for you in the marketplace.
As long as this company was growing 25% sequentially, which it was supposed to be going into this year, there was no price too high to pay for it. At least I thought so. As long as we bought every dip in the stock, literally every dip, we made money. Momentum buyers knew this and took apart the shorts every single time it dipped. It always worked. This stock defined the "buy on dip" recipe for success that has turned into a recipe for disaster.
As soon as Brocade started intimating at conferences that it could no longer deliver that kind of growth, that pie-in-the-sky calculus that worked so well suddenly vanished as a "methodology" for making money in the company.
Now, though, the question becomes, what price can you pay for Brocade once the better-than-expected spell has been broken? Here's one way: Professionals take the estimates, let's say 70 cents for the year, and give it a multiple in relation to other stocks. They ask, "How much faster is Brocade growing than other stocks?" If it's growing three times faster than others, on the basis of year-over-year comparisons, then they are willing to pay three times the market multiple.
For ease, let's say it's growing three times faster and that the market's multiple as defined by the S&P 500 is 23 times earnings. That means pros would be willing to pay 69 times Brocade's earnings estimates, or maybe roughly $50 (69 times 70 for the arithmetic). With the stock currently at $40, that's not a lot of upside.
But it gets worse. Why, if everything is getting so progressively more competitive in the storage space that Brocade works in, should we have any confidence in the 70-cent estimates? In fact, knowing Reyes, wouldn't this be precisely the point at which he would want to take it to McData (MCDT:Nasdaq - news - boards) on the high end and Inrange (INRG:Nasdaq - news - boards) on the roachy low-end and annihilate the competition, even if it means hurting earnings? Maybe he'll earn only 50 cents if he does that. Now his earnings would be showing little, if no growth. That means you would pay a discount multiple to the market of maybe only 20 times. That gives you a price of 10 bucks! Holy cow! Now there's some downside!
And yet that's precisely how the institutions that are now determining prices think. They don't think like individuals who tend to say, "Let's just hold it, it's bound to come back," because these institutions have seen many best of breed tech companies never come back once they got into these spirals.
In fact, if you know that Brocade isn't going to beat those estimates, it becomes a nonmomentum stock, one that must be sold by the likes of Firsthand and Janus, not bought. In other words, look out, a massive amount of supply could hit the market.
That's why Brocade is the ultimate tell of this tape. It's the perfect stock to measure how the high-multiple stocks will fare. And as much as I love Reyes and the company, I don't think it will fare very well while it wipes out the competition.
Should you short Brocade? Not on your life. You don't short great managements and good companies, even if you think they're too expensive. Consider that Brocade traded at $32 early last week on the news of its problems. Short-coverers and so-called bottom-fishers then took the stock right back to the $40s. You would have been crushed if you'd shorted that break.
But should you be long it? Right now that's just as dangerous as being short it. In fact, the trader in me bets this stock sees that low from last week again sometime.
Which means the best bet is to stay on the sidelines. That's how I would play it.
thestreet.com
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Yeah, yeah, I know it's Cramer.
Let's break it down.
- great management
- dominant market share
- growing faster than the market
- well off it's high
- storage alliances with all storage players
and he's indecisive and wants to stay out.
Jack |
