Several companies for one reason or another choose not to split their shares. Should investor enthusiasm build, shares can extend into the triple or even quadruple digits. While in some cases this enthusiasm is warranted, in other cases, I believe it is not. Here I will recommend three longs and three shorts, all of which have share prices over $100. Here are my criteria for Longs:
- Adjusted P/E below 15x or P/B below 1.5x. I adjust the P/E to remove any net cash from the numerator and normalize earnings. For Tower Properties I adjust to give an approximation of funds from operations (FFO), or what it would report were it classified as a REIT.
- History of intelligent capital allocation - timely stock buybacks, value accretive acquisitions, or large dividends paid to shareholders.
- Strong balance sheet - prudently financed companies with limited financial risk.
On the short side, my criteria are as follows:
- P/E greater than 75x
- Market capitalization greater than $1 billion
- Unproven business model with limited history of earnings/cash flow
Apple (NASDAQ:AAPL) is an example of a well-known, inexpensively priced company hiding in plain sight. While shares underperformed the S&P 500 in 2013 as Apple posted a year over year earnings decline (for the first time in many years), there are many reasons that Apple is a promising investment prospect for long-term investors. First, user loyalty remains strong. Almost everybody who enters the Apple ecosystem stays - this ensures a long stream of future cash flows to the company. In a sense, it is recurring revenue as people replace iPhones every two years or so (and about every 3 for iPad). Secondly, Apple has become far more shareholder conscious, returning over $30 billion to shareholders via buybacks (at an attractive price) and dividends in 2013. The company has stated that it will continue to buy back stock in 2014. Lastly, Apple continues to have growth potential as evidenced by its recent agreement with China Mobile which will bring millions of new users into its ecosystem. At an ex-cash P/E of just 12x, Apple looks inexpensive. Companies with strong brands (Apple being the #1 brand in the world) and a high percentage of recurring revenue tend to sell for premium multiples, even as growth slows. Were Apple to trade up to 18-20x earnings, we could see shares rally 40%.
Berkshire Hathaway (NYSE:BRK.A) shares trailed the S&P 500 during 2013 and trade at just 1.4x book value. Book value is understated as many of the company's fully owned operating subsidiaries (Burlington Northern, See's, etc.) are worth far more than book value. Berkshire has deployed capital at high rates of return over the past 5 years including its purchase of the Goldman Sachs, Bank of America, and GE convertible preferreds. Similarly, its acquisition of Burlington Northern has proved to be a win for shareholders. With Warren Buffett still actively involved and new investment talent like Todd Combs continuing to allocate a larger percentage of the portfolio, it is reasonable to expect that Berkshire will continue to create value for long-term shareholders.
Tower Properties (OTCPK:TPRP) is an off the radar small cap real-estate holding company (mainly apartments in small towns). It is not structured as a REIT and does not pay a regular dividend, though it has made large special dividends, most recently a $2065/share dividend in 2012 (equal to ~25% of its then share price). Because it is not a REIT, it doesn't screen well (does not report Funds From Operations for instance) as its large depreciation charge obscures its tremendous free cash flow. Note that while Tower is recording a depreciation charge, its properties are likely worth more than the un-depreciated asset value stated on the balance sheet (given that many have been held for 10 years). This is further evidenced by the company's strong free cash flow - adding back the annual depreciation charge gets us to ~$1,200/share in FFO (which it would report were its corporate structure modified). This means the company is trading at a P/FFO less than 8, or offering a 12% free cash flow yield. While apartments in small towns aren't going to trade at 4-5% cap rates we see in large metropolitan areas, I don't think they should trade much higher than 8%, implying 50-60% upside in Tower shares.
Founded in 1994, Amazon (NASDAQ:AMZN) is one of the oldest "new economy" stocks with revenue approaching $80 billion. Yet the company is having a difficult time translating its tremendous revenue into profits. While bulls argue that this is because the company is constantly investing in new areas, I'd argue that it operates in highly competitive businesses (general merchandise retail, cloud services, etc.) and leads with price (or cheap/free shipping). While this has allowed it to put the hurt on its competitors, I think it is also holding down its margins. Though I think the company could improve profitability overnight by cutting back on growth initiatives and increasing pricing, I also think this would dramatically slow its growth rate and investors would place a much lower multiple on the business. Further, I think Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) have dramatically improved their websites/fulfillment and are much stronger competitors than in years past. Though I'm a happy customer of the company, I think Amazon's shares are well ahead of themselves at nearly $390/share (2.3x revenue, 850x 2014e EPS) and see 30-50% downside if the market takes a less optimistic view of the company's prospects.
Altisource Asset Management (NYSEMKT:AAMC) was one of, if not the best performing stocks of 2013, up over 1200%. The market responded positively to an improving housing market and successful capital raises at Altisource Residential (NYSE:RESI), a REIT for which AAMC serves as the external manager. In return for services rendered to RESI, AAMC receives expense reimbursement as well as an incentive fee (a more detailed description of this arrangement as well as some of its potential pitfalls can be found here). As AAMC does not produce any earnings yet, and is wholly dependent on the success of RESI, I've decided to look at AAMC/RESI as a combined entity based on a P/B multiple. This makes sense as RESI will be sharing 50% of dividends greater than $1.03/share with AAMC. Adding the market cap of AAMC to RESI, I get $3.3 billion which compares to a book value of around $850 million or a 3.9x P/B multiple. This is significantly higher than peers like American Homes for Rent (NYSE:AMH) which sell close to 1.2x. While I believe that RESI is overvalued (at 1.5x book), the bulk of the overvaluation lies in AAMC (which represents 70% of the combined market cap and very little of the book value). A return to a multiple more in line with peers (1-1.3x) could be ugly for AAMC shareholders which could see shares fall 80%.
Tesla (NASDAQ:TSLA) has been wowing drivers and investors alike with its futuristic electric vehicles. The market has awarded it with an unheard-of valuation for an automaker, trading at 6x 2014 estimated revenue (9x 2013 estimated revenue) and 100x a generously estimated 2014 earnings figure. While I've heard good things about the cars, I'm concerned that the valuation doesn't allow for the many growing pains to be expected for a start-up automaker including: 1) supply chain issues (particularly batteries) (2) potential quality problems and warranty obligations - this risk is more significant than for any other automaker given how new the technology is (3) similarly Tesla has guaranteed the residual value of its vehicles on lease (4) capital required to build out charging stations. While nobody is worried about this now, in a downturn, residual values can be a huge concern. Lastly, the auto business is a fiercely competitive, low margin, low return on capital employed business. Can Tesla do better? Maybe, but today's valuations assume that the company will do substantially better with minimal pitfalls along the way. Given the complexity of the automotive supply chain (thousands of bought-in components from suppliers all over the world), I'm anticipating some bumps along the way and think shares could fall 50-60% should difficulties emerge.
While Tesla and Amazon (I'm not so sure about Altisource) are providing innovative, value-added services to their customers, I think shares are well ahead of themselves whereas Apple, Berkshire and Tower aren't receiving the credit they deserve from investors.
Additional disclosure: I am short AMZN, AAMC, RESI.