Playing Earnings On Tech Stocks In The Investor's Business Daily Top 50

by: Ted Stamas

According to Jim McTague in his excellent book "Crapshoot Investing," the average holding time for a security is two and a half months as compared to four years back in the 1970's. I'm a bit of a statistical anomaly in that I like to own my securities for over 12 months to take advantage of the long term capital gains rates, although I have sold in under a year when circumstances dictate. Sometimes you just have to take your profits, especially if you've got a high flier with an astronomical P/E ratio.

During earnings season, when an equity misses analyst projections, it can get crushed. The reverse is also true when a hot stock reports eye popping numbers. They tend to go through the roof. A good example of this on both sides of the ledger is Informatica (NASDAQ:INFA) with its recent trading history. I originally covered the stock in an article in late March when the stock was trading at $48. It was also prominently displayed on the Investor's Business Daily top 50, a list I religiously follow.

In that post I thought Informatica was a good momentum play, but its P/E Ratio was too high for my portfolio. I believed the stock would come back down in its valuation level, and, it has, but it's been an incredible journey. Four months after that writing, the stock shot up to $62 on a good earnings report, then came crashing down to $35 after its next conference call. It is now crosses the consolidated tape at $47, so it really hasn't budged if you are long. Then again, the overall market hasn't moved much either. There's just been an enormous amount of volatility.

Yahoo Finance has earnings estimates for Informatica at $1.39/share for 2011, and, $1.66/share for 2012. It also has a 20% growth rate for not only the current year, but, the next 5 years compounded annually. This gives us a current P/E Ratio of 34, and, going forward, a P/E Ratio of 28. When you consider the growth rate, the P/E metric is a no-no in the eyes of value investors. But it might be what you are looking for if you want a stock that is in play.

Besides its impressive 20% growth rate, one of the main reasons the stock is in motion is because of investor psychology. Informatica is a minor player in the data mining sector, and, this is where the action is as we build out the cloud. There is no shortage of information available to the enterprise, and, Informatica enables big business to amalgamate e-mails, social media, video and graphics into one tidy package. The media love affair for companies that either build, or, facilitate information for Internet 2.0 has not waned. Informatica is a beneficiary of this.

That said, the company has been dethroned from its perch high atop the Investor's Business Daily top 50, and, although it has a lot of promise for an underdog, there are other stocks with the same modus operandi that have pulled rank. Two diamonds in the rough I am currently monitoring trading near their 52 week highs are CommVault Systems (NASDAQ:CVLT), and, SolarWinds (NYSE:SWI). Both are speculative securities that have graced the IBD 50 of late, and, are also minor players in the backbone of the enterprise cloud.

You can overpay to comical proportions for stocks on the IBD 50 because of their inflated P/E Ratios, but many times they deliver a hefty payload. SolarWinds and CommVault certainly fit that bill by doubling in a stagnant market. The question is, when do you get out of them? You hear portfolio managers on CNBC saying that you have to be nimble in this market if you want to make any money. Investor's Business Daily suggests putting stop/loss orders in. I don't like to do that because sometimes a stock can drop for no good reason, and, you'll sell too early. However, if you are of the short-term traders mind-set, this may be a good strategy for you.

Without crunching numbers, I tend to favor CommVault over SolarWinds because they have a less pedestrian product. CommVault's Simpana 9 software is a compression technology for data storage in the cloud. Dell (NASDAQ:DELL) accounts for 25% of its revenues, and has been rumored the be interested in acquiring the company. CommVault has also been taking market share from rivals Symantec (NASDAQ:SYMC) and IBM (NYSE:IBM). According to Investor's Business Daily: "This year it signed storage firm NetApp (NASDAQ:NTAP) as a customer under a three-year distribution agreement. NetApp will integrate elements of CommVault's Simpana 9 under the NetApp SnapProtect brand. CommVault has a similar arrangement with Fujitsu."

Where CommVault has the superior technology in it's space, SolarWinds is taking share from much larger players IBM, Computer Associates (NASDAQ:CA), and, BMC Software (NASDAQ:BMC) from a different tactic: word-of-mouth advertising. SolarWinds produces network management and monitoring tools that are, not only less expensive than their rivals, but they do the same job, too. Reduced costs are obtained by not having a sales force in the field. Everything is done on the Internet. A business model much like the one Amazon (NASDAQ:AMZN) has. In a cost-cutting world, it gives them a leg up.

In examining the measurables for SolarWinds (SWI), we can see that their current year earnings/share is $0.99, and, for 2012, $1.11, roughly a 10% gain although SolarWinds 5 year CAGR (compound annual growth rate) is projected to be 19.33%. At $30/share, this gives us a forward P/E Ratio of 27. Much too expansive for a value investor when the growth rate is 10%. Even if you use the 5 year CAGR of 19.33%, you still get a PEG Ratio (price/earnings/growth) of approximately 1.5. That's not too expansive, but it's not rock bottom for a company that is in the middle of a global debt crisis.

In looking at CommVault's numbers, we get a different story where valuations are concerned. Both companies have almost identical econometrics according to Yahoo Finance. However, CommVault is trading at $45/share, about 30% higher than SolarWinds, obviously a premium price for the more dominant technology. Its current P/E Ratio is 48, and, going forward one year, we get that same ratio at 41.5. This is very expensive for a stock that is projected to grow at only 14% next year. The CAGR for the next 5 years is 20%, but even if you use this figure, the PEG Ratio is still elevated.

My strategy is to stay away from stocks like CommVault Systems and SolarWinds, and, pick them up at a later date when they aren't in motion. Stocks on the IBD 50 usually have a limited shelf life. Some examples of interesting stocks that are taking market share from companies with long and storied histories that have graced the roster, but have been tossed aside, are the above mentioned Informatica and Aruba Networks (NASDAQ:ARUN). However, I go for value, not momentum, and your take may be different. To me, these stocks are booby-trapped with traders just waiting for the little guy to come wandering into the fold, only to get blindsided by a bad earnings report. We are light-years away from the 90's. Momentum can only take you so far these days.

Before I close, I'd like to say that I don't want to whitewash any issues, or, come off as an unrepentant huckster, so I'd like to clarify my investing position. I am short the market with inverse ETFs. Most specifically ProShares UltraShort S&P 500 (NYSEARCA:SDS), and, Direxion Daily Small Cap Bear 3X Shares (NYSEARCA:TZA). I've owned these ETFs for well over a year, and, with the wizardry of Wall Street, am able to short the indexes without a margin account. My take is that we are in an interlocking network of global financial debt that needs to be deleveraged before I continue investing in individual securities.

My posts are part of a reconnaissance mission to gather information on what I'd like to invest in once the sovereign debt crisis is resolved. Some of these stocks are household names, and, some are not so familiar. One thing they have in common is that they are part of a technology movement that is accelerating at a rapid pace. It's tough to keep up with it in your portfolio, and in your personal life. This is not your grandfather's market where you could buy widow and orphan equities and just forget about them for a decade while reaping big rewards.

Disclosure: I am long SDS, TZA. I am short the market with inverse ETFs.