COMMENTARY: Wild Rumors More Powerful Than Fundamentals
Is this true and if it is, how can anyone who is not totally connected, win in this market?
The Market seems more manic than ever, with wild twists and turns, even intraday. But what's really troubling is when unfounded rumors or mis-statements by others, can be so powerful that they override fundamentals and technical analysis and wreak short term havoc. It is extremely troubling if you think about it, because good fundamentals are supposed to protect, and even reward us, right? I mean, that's what we've always been told.
Below is a recent case study of one stock with excellent fundamentals that by any measure was and is highly undervalued.
Check Fundamentals at Nasdaq.com
here:http://earnings.nasdaq.com/earnings/analyst_summary.asp?symbol=ESST%60&selected=ESST%60
CASE STUDY OF ESST
This company is in the hot, highly growing DVD sector. In their recent earnings report, they:
** Beat consensus by 10 cents.
** Guided higher.
** Increased Gross Profit Margins to 43%, from 22% a year earlier, and from 41% in the previous quarter.
Mr. Blair, of ESST, continued, "We were surprised by the strength of the DVD market in the traditionally slow first quarter. ESS has now shipped a record number of units for three quarters in a row. We believe we once again expanded our No. 1 market share position during the quarter, to over 40% of the worldwide DVD market. Our DVD revenue grew to over $45 million during the first quarter, with a 780% year-over-year increase in unit shipments and a 6% sequential quarterly increase in units.
"We intend to continue to grow market share and strengthen our leadership role through the introduction of five new major product families over the next 12 months. With these new product family introductions, we believe we can continue to lead the high growth market for digital home entertainment products." Mr. Blair concluded.
Stock rises a little, then drops 35%
Yet, the Companies stock to the horror of many was to drop over 35% at one point over the next two weeks (i.e from 20+ just after earnings to under $13). How could this happen?
Fundamentally Undervalued
PEG (P.E. to Growth) ratio under .50 indicating about 50% undervaluation since a ratio of 1.0 is considered undervalued in tech.
PE 12 compared to competitor ZRAN's 35 and industry PE of 90.
(btw, ZRAN has had less than half the eps earnings over the previous four quarters).
What Happened After the Earnings Report
The stock rose about 2 points in afterhours to $20, but started tanking the next day. In fact, it went from $20 to below $13 over the next couple weeks. The Yahoo boards revealed a nasty battle going on with seemingly endless headlines of "STOCK GOING TO $10", then "STOCK GOING TO $5." No real reason was usually given, of course.
Meanwhile, the short position kept increasing to as high as 40% or more of the float, even after the earnings report apparently.
Then, several days later a rather strange report appeared in the Wall Street Journal that ESST might be hurt if DVD sales slowed. That's right...IF that happened. "If"? That's seems a bit odd, especially when other sectors would love to have anywhere close to this sector's growth. Just ask Microsoft, Intel, or IBM.
Furthermore, why did the report seem to target ESST more than other companies in its niche? Did the 40% short interest have anything to do with it? Perhaps, perhaps not, but it might bear investigating.
But the point is that there is little if any signs that growth will slow or slow dramatically. Consumer spending worlwide is strong in this sector. Most major research groups, and ESST and other companies, indicate demand is strong worldwide and expects it to remain so. In fact sales of recordable DVD players are expected to go up 725% this year, according to industry sources.
The Company reported in their recent Press Release on earnings:
"We expect to grow our DVD revenue by 10% - 20% in the second quarter of 2002 compared to the first quarter, and expect overall revenues for the seasonally slower second quarter to be $76 - $79 million, up from our previous guidance of $66 - $70 million. We expect earnings per diluted share to be in the range of $0.24 to $0.28 (GAAP basis)."
The Stock Kept Falling
Well, the stock took a small hit after the WSJ article appeared to below $15, but then rose higher and higher. It appeared the "shorting game" was over and fundamentals might have some meaning again.
But, no, ESST stock soon started dropping again, easily breaking chart support at $15 and crashing to below $13. So what was causing this latest fall? The small guy had no idea.
Meanwhile those investors who paid $18 for the stock before the earnings report were now down 30% and those who bought May 20 call options were really underwater, nearly "dead".
At $13, ESST's PEG was about .38 and their PE 11. Meanwhile competitor ZRAN's stock was about $35, with a PE near 36(remember they had less than 1/2 the earnings of ESST in the last 4 quarters) and an industry PE near 90.
So why had ESST's stock plummeted even further. Well, the rest of us finally found out when the company felt compelled to speak out. It was something called the CFRA Report.
ESS Technology Announces Share Repurchase Program And Comments on CFRA Report
FREMONT, Calif., May 7, 2002 /PRNewswire-FirstCall from COMTEX/ -- ESS Technology, Inc. (Nasdaq: ESST chart, msgs), a leading provider of silicon solutions for digital video, home networking, and digital home systems today announced that its Board of Directors has authorized the company to repurchase, at market prices and as market conditions warrant, up to 3,000,000 shares of ESS common stock. The stock will be repurchased on the open market from time to time at management's discretion. The 3,000,000 shares authorized for repurchase today include approximately 600,000 shares that remain available for repurchase under ESS's previously announced repurchase plans.
Robert Blair, president and chief executive officer of ESS Technology commented, "We believe that ESS is succeeding in achieving our strategy and objectives, including becoming the number one supplier of DVD chips worldwide, improving our historical margins, and adding over $62 million in cash from operations to our balance sheet during the last 2 quarters. We believe our stock is very undervalued and the current share price provides an attractive opportunity to reduce the outstanding shares and enhance shareholder value."
Mr. Blair continued, "Separately, we are aware of a report recently issued by the Center for Financial Research and Analysis, Inc. (CFRA) which is extremely misleading. The report implies that ESS may be hiding expenses to inflate its operating profits by having its former subsidiary, Vialta, Inc., pay for these expenses. This is absolutely false. ESS spun off Vialta to ESS's shareholders in August 2001 so that investors of either company would have more visibility into the business and finances of both companies and the two companies have been operated as separate independent public companies since that time. Prior to the spin-off, ESS provided various R&D and administrative services for Vialta. This information is shown in the enclosed table and has been reported in our respective 10Ks and 10Qs. As you can see from the table, the primary expense paid by Vialta to ESS since the fourth quarter of 2001 is for the lease of one of ESS's buildings at market rates. To imply anything improper is being done is false, misleading, and a disservice to both ESS's and Vialta's shareholders and employees."
Of course, the stock rose several points in the next couple days after the report, then retraced again. It currently stands above $15.
So, to recap, this stock with 1/8th the PE of its competitor ZRAN, has dropped about 25% after it earnings report in which it beat the street consensus by 10 cents and guided higher. A questionable report of "what if" DVD sales growth slowed appeared in the WSJ, which flew in the face of other growth research. Then an overblown concern that took the price down to a PEG of under .40 for a stock that had grown earnings over 119% in the last year and one that had a PE that was 1/8 that of the industry group in which it finds itself.
This is the best (or worst) example of how manic and fearful our Market has become. A market where wild rumors can completely destroy the portfolios of investors who are trying to do their Due Diligence. If Fundamentals don't matter anymore, and any stock can become the target of an apparent powerful group of shorters who can use questionable information to panic investors, how can the small guy win?
Indeed, what stock is safe from any powerful shorting group who could use any number of over or undervalued stock to target?
And my big question, with stocks like TER at $30+, a company who is expected to lose .97 per share eps this year, why was ESST targeted and not the many stocks like that? |
