In several Seeking Alpha articles - most recently, Note to Apple Fans: Stop About Talking Value - I argue that financial metrics, such as valuation measures, mean little in relation to the prices of certain stocks, both in the short- and long-term. The following points comprise the key components of my contention:
- Less concrete and often downright abstract notions of noise, potential, emotion, and "the story" drive stock prices, not P/E ratios.
- Using valuation data represents the old guard's way of predicting stock price movements, over the short- and long-term.
- Investors misinterpret P/E ratios anyhow. Low P/E ratios do not necessarily indicate an "undervalued" stock. High P/E ratios do not necessarily imply an "overvalued stock." Rather, they represent investor confidence vis-a-vis a company's ability to achieve expected growth over the long-term.
- As such, highly-watched and/or heavily-traded high-flying stocks will likely never "grow into a valuation." They will likely always be "overvalued," as long as the long-term story and bullish investor sentiment remains intact. Inversely, "undervalued" stocks with broken long-term stories and negative sentiment often never reverse course.
In previous articles, I outlined two other related facets of my investment philosophy. As I evaluate a stock I consider the company's present and future ability to create, nurture and exploit internal and external synergies. Along similar lines, I look for the existence of - as well as - the potential for multiple revenue streams. I want to know if a company can use diverse sources of revenue to hedge weakness in one source and drive business to its core revenue stream(s). These points represent part of "the story" that I refer to.
Of course, it takes more than one or even a few articles to sufficiently elaborate an investment approach. In this article, I look at several stocks that I have bullish or bearish views on, irrespective of their "valuation." In doing so, I hope to better define my notion of "the story" and show how, while not quantifiable like a P/E ratio, you can still use aspects of "the story" to assign worth to a company and its underlying stock symbol.
Tesla Motors (TSLA): Assuming Tesla carries out its business plan over the next several years, it will always be overvalued, by the book. You can read my previous articles on the company and check out its financial reports, but, for the sake of argument, let's agree on several points:
- With a market cap of nearly $3 billion and EPS of -$2.39, TSLA sports a lofty "valuation," to say the least.
- Tesla will sell out its first- and second-year runs of the new Model S.
- Tesla will continue to increase development services-related revenue.
- Using extremely conservative estimates, the Model S will generate at least $287 million in revenue from its initial run and $574 million in sales from its second production run. These low-ball estimates do not include revenues from development services and other sources.
- Tesla will break even or post a small profit or loss by the end of 2013.
Unless Tesla fails, coming in around or exceeding this forecast should trigger a rise in its stock price. If the company performs better than my conservative outline, the stock will rise and investors will look to Morgan Stanley's (MS) bullish outlook as having been prescient. I buy the stock, obviously, because I believe the bull case will come to.
If I look at valuation, I would not buy TSLA today. It's too "expensive." I buy because of my perspective. I live in Santa Monica, one of the nation's most affluent cities. The Toyota (TM) Prius is ubiquitous here and so are outrageously expensive luxury vehicles. In my view, Tesla knows its market well and is all but guaranteed to capture a considerable subset of that this well-heeled niche.
Let's be clear, I am buying "the story," which my place in life and space informs. People chide me for buying such an "overvalued" stock that will have to do quite a bit to "grow into its valuation." TSLA will never peg to its true "value" as measured by old guard investors. It's a hyper-growth company. You should expect it to be "overvalued" from here to eternity. Tesla's stock price relative to its valuation means absolutely nothing. If the stock tanks, people will say, "see, it was 'overvalued.'" No, it never was; it just failed to tell the rest of the story. It's a fine, but real distinction.
Sirius XM (SIRI). Sirius XM has debt. When it doesn't break even, it basically ekes out a profit. It sports a P/E ratio of more than 201. Even at $2.00 a share, it's horrifically "overvalued." While I initially acknowledge them, I effectively ignore and leave these "financial metrics" up to the frustrated MBAs of the world.
From a "story" standpoint, Sirius XM runs in a pretty competitive space up against terrestrial radio, Internet radio such as Pandora (P) and other audio entertainment players such as Apple (AAPL). I think it beats or holds its own with the competition for several reasons which I outline in my body of work on the company. These reasons center around my confidence in Sirius XM CEO Mel Karmazin.
In my articles, I discuss what the company is up against - competition, reliance on auto sales, the need for more diverse revenue streams, the need to become a brand with mass market and mainstream appeal, and the need to take the functionality and interactivity of its service to the next level with the forthcoming SatRad 2.0. Clearly, I pay attention to what could go wrong. As a long, obviously, I place the bet that the story plays itself out well. This decision has absolutely nothing to do with valuation. If I am "right" about Sirius XM's future, investors will run the stock up to a point where it will remain "overvalued." If I think the story has exciting chapters remaining, I will buy more, regardless of what business students and Warren Buffett disciples would do.
Consider an analogy that helps drive home the case for TSLA and SIRI. I like to dabble in penny stocks. It makes me laugh when penny stock "investors" cry about dilution in the share structure of a development stage company. The company went public in the first place so it could sell shares and continue to use the proceeds to develop its business, for goodness sake.
You should only buy a penny stock to flip it or to hold for the long-term on the conviction you have in the probability of its eventual success. Dilution means nothing. If the company executes its plan - in other words, validates your belief in and perception of its story - the dilution you once cried about ultimately proves inconsequential. The same type of argument applies to valuation. If Tesla and Sirius XM execute, who will look back and say anything about valuation? It's not relevant. And it will not be relevant when by-the-book investors brand a consistently and highly-profitable Tesla or Sirius XM overvalued two, five, or 10 years burnin' down the road.
In the next segment, I will discuss two stocks I am bearish on - Netflix (NFLX) and Research In Motion (RIMM). Both provide interesting case studies on the valuation versus "story" angle I get into here. You could argue that NFLX represents an "overvalued" stock and RIMM an "undervalued" one. In each case, again, valuation proves to mean little today or looking out into the future.
Disclosure: I am long SIRI, TSLA.