"If a business does well, the stock eventually follows." - Warren Buffett
I get bothered by many things in life. No, it's not because "Cameron is inherently irritable" but it's because (by nature) I'm inherently logical - at least I think so anyways. This bothers a lot of people, for reasons I don't care to know. If you believe that 1+1 equals anything but 2, then you and I probably will have a hard time getting along. Because during your period of trying to convince me to think of other possibilities, I guarantee you that (in my head) I'm likely devising a scheme to exit the conversation and to never look back.
The Market Is Not Stupid
However, I try to deal with my irritable tendencies in many ways. But there are certain times where regardless of any level of effort I put in to deal with it, I completely lose it, because as you can imagine, my list of irritable things is pretty lengthy - where some are more egregious then others. Right between leaving dirty dishes in the sink and someone purposely taking up two parking spaces, is the blatant use of the term "undervalued" in the stock market - one very subjective and biased word that I realize that many investors throw around recklessly without truly appreciating its meaning.
Be that as it may, it is a term that requires deeper understanding as it suggests many things. Not the least of which is that if you consider your stock undervalued, then you need to explain where it should be traded relative it its earnings and its current P/E. I don't immediately get annoyed because the term is used. I get annoyed when it is not followed with additional analysis. If 1+1 should equal 3 in your eyes, then be prepared to explain why. "The market is stupid" is not enough of an answer - if that's all you've got, then you and I have nothing left to discus because it then becomes evident that "logic" by its definition does not matter to you.
What's the Problem?
Sirius XM (NASDAQ:SIRI) is one of those stocks that many investors always complain is undervalued and unfortunately (for me) I have to ask why? I suppose that's the masochist side of me, but nevertheless, I think it is fair that I not pass judgment until I first seek to understand. With the stock being as high as $2.31 as of last Friday's close, it led to some serious discussions over the weekend regarding the stock's "fair market value" as well as where it is likely heading. I have heard $3.00, $4.00 and even $10 in a couple of years. But when these projections are coupled with the words, "Sirius does not trade on fundamentals" then I am left scratching my head.
So essentially, I am told that I should expect the stock to arrive at $10 in a few years, yet I should not worry about the problem in the math. In other words, forget 5+5, 6+4, 7+3 and 8+2. When it comes to Sirius, remarkably none of that matters, not even how it operates its business. The big discussion regarding Sirius these days surrounds Liberty Media (NASDAQ:LMCA) and the fact that it may acquire Sirius at some point this week. I'm already on record of saying that nothing is going to happen this month - if at all this year. But the question is, does any acquisition change the underlying fundamental value of the asset - absolutely not.
It continues to amaze me how that logic often escapes the appraisal process. Sirius is now worth $3.00 because Liberty wants to buy it. How does that make sense? Will any anticipated acquisition spike up its Q4 earnings number or its guidance for the year? So for a stock that recently traded at a P/E of 33 to yet be considered "undervalue," makes no sense at all. So as you throw out the term "undervalued" you need to also ask yourself, what is the problem?
Using "Undervalued" Properly
While I'm not proclaiming to be an expert, I don't want this to be a case of "pot and kettle" because I use the term quite a bit myself in several of my articles and most recently to make a case for Microsoft (NASDAQ:MSFT). In that context, my argument is that the company's share price has not grown commensurate to its earnings. I also added the following:
- This is in contrast to its pre-tech bubble valuation where the argument can be made that it was then overvalued because it simply rose too much and too quickly. The stagnation in the share price since then has had a lot to do with the fact that it has not been able to fully recover from that drop by virtue of its (then) inflated valuation back in the late '90s. But clearly investors can now see evidence that its uptrend is primed for resurgence - one that started at the beginning of this year.
- Given that the past two decades the company has traded on an average price-to-diluted-earnings ratio of 26.70, multiplying those averages with the earnings per share each year, the company is undervalued by at least over 50% - this is also taken into account its low P/E of the last five years as well as some conservative assumptions. I will concede that my model is not perfect and highly biased, but the company should be trading right around $52 per share if the market made any sense at all.
Right or wrong, it showed how I arrived at 2 from 1+1. So for investors who are tired of hearing from analysts about how overvalued their stocks are, instead of complaining that it really is "undervalued," investors should demand more earnings from their investments. After all, the best way to prove the naysayers wrong is for the companies themselves to deliver better-than-expected performances and grow into that valuation.
With March 6 having arrived, it will be interesting to see what the stock does. Having already reached a level that's expensive, I suspect that there are some who yet bought on anticipation of "missing a run" while the pros have likely taken short positions in anticipation of its retracing to its "fair market value." The "bull trap" was in effect and based on the share price action the past couple of days, it looks as if it was executed to perfection. But it is still too premature to say with any degree of certainty what will happen over the course of the next couple of days. But two things that I feel pretty comfortable about is that first, if a business does well, the stock eventually follows" and second, "Liberty will stand still."
Disclosure: I am long MSFT.