Seeking Alpha
Profile| Send Message|
( followers)  

We, as investors, spend hours upon hours researching, analyzing, and juxtaposing equity investments before biting the bullet and taking the risk. There are golden companies like Apple (NASDAQ:AAPL) who are fundamentally sound and undervalued investments with tremendous growth potential, but there are also companies like Amazon (NASDAQ:AMZN) and Salesforce (NYSE:CRM) whose valuations defy all odds. These are companies that, in the short term, have performed extremely well because of large revenue growth potential, but have business models that suffocate profitability. Here's my list of 6 stocks, 4 to consider investing in and 2 to avoid.

Apple

Apple is, has been, and will be the largest equity position in my portfolio. In the past month, we saw Apple fall from $644 to $530 as investor sentiment went from blind confidence to obscene panic. Some rode the waves of panic as Apple plummeted 17.7% in a matter of 5 weeks, while others quickly liquidated their positions adding to the downward pressure.

Stories of hedge funds dumping their holdings continued to ignite the blind panic, but even Apple's blowout earnings report couldn't provide the much needed price support. We've now experienced 3 weeks of upwards momentum which has helped build investor confidence again, but I must agree with some commentary that Apple has transgressed from an investment stock to a day-trade stock. Personally, I stay away from day-trading because, in the end, it's pretty much impossible to really know which way a stock will trend. Panicked investors are irrational and behave in unpredictable ways.

WWDC has finally arrived. Apple's rumor mill has really run its course in the past week, speculating ideas from the Apple TV to Apple's iMaps, Siri for iPad, and iOS 6 with possible Facebook (NASDAQ:FB) integration. Apple's new MacBook air provides stunning picture quality with its retina display, with an incredibly powerful solid state drive and Nvidia graphics processor. "All-in-all, the new Air is twice as fast as the previous model" (Yahoo Finance). I found this article highlighting the keynotes of Apple's WWDC conference extremely useful. I've previously stated that Apple wouldn't unveil its TV this week, but will reserve its release for later in the year. Also, to the gloom of many, Apple's iPhone 5 is still underground with no official hints of its release. I believe, though, that Apple will release its iPhone 5 around October 17th. Despite Apple failing to release its TV or iPhone 5 at WWDC, it's still an intensive growth, innovative, dividend paying company, providing products and services consumers demand intensely globally.

Apple has done a tremendous job in creating and sustaining its mobile market share presence by aggressively contracting with new mobile providers like Sprint, T-Mobile, and currently in talks with China Mobile. China Mobile, alone, will expose Apple to a 665 million subscriber base, dwarfing Verizon and AT&T's subscriber base by over six times.

For a much deeper, in depth analysis of Apple's business and market risks, view my article, "Bite The Apple Before It's Too Late."

Cheniere Energy (NYSEMKT:LNG)

Cheniere Energy is a Liquefied Natural Gas export facility located in Houston. It currently holds an exclusive natural gas exporting license to non-U.S. Free-trade associated countries, giving it unrestricted global exporting rights. Recently, Sempra Energy (NYSE:SRE) was also given an export license, but its exporting ability is limited only to limited, approved countries.

Liquefied Natural Gas has been the key success in natural gas exports during the 21st century. It's a process of freezing natural gas to such a cold temperature that it liquefies and condenses into 1/600th its usual volume. This makes transportation cost-efficient and makes arbitrage opportunities from exporting natural gas very lucrative.

Recent developments in the natural gas market in America have made Cheniere Energy's potential astronomically high. A combination of a severe natural gas glut with increased demand from China, India, Spain, and Korea have created a perfect situation for Cheniere Energy to profit from.

As many investors know, we're still experiencing a natural gas price glut because of immense natural gas over-supply from a process called hydrofracking. In fact, this process has been so successful that it has become the reason why natural gas prices in America have plummeted from over $13/btu to under $2/btu. Another way to look at this is that in 2000, the U.S. natural gas production was 53 bcf/d (billion cubic feet/day) of natural gas; that figure sky rocketed to 83.17 bcf/d by January, 2012.

U.S. supply has simply outweighed domestic demand, resulting in the plummeting natural gas prices. Although we're experiencing an over-supply of natural gas domestically, global markets are experiencing natural gas shortages. By the end of 2011, Japan's average LNG price was at $14.97, a large premium to our suppressed prices. Reports indicate that prices in China and India fetch similarly high premiums.

Cheniere Energy is currently in a very unique position. It's stationed in a country experiencing a massive natural gas over-supply, with a business process allowing it to capitalize on this once-in-a-lifetime arbitrage position. Recently, Cheniere Energy has been given regulatory approval for a $10 billion expansion of its LNG exporting facilities, to be functional by 2015. The global economy's turnaround has been paramount in sustaining high global natural gas prices which are, and will be, paramount in Cheniere Energy's success. With China, India, and South Korea's expanding economies, demand for liquefied natural gas will increase sharply, providing increased future profitability for Cheniere Energy.

This report projects that from 2009-2035, global consumption of natural gas will rise by 56%. The cogs are falling into place, not only from cars running on natural gas, to federal and state tax incentives for businesses to utilize natural gas, but also from a global requirement for this sustainable, cheap, and clean future energy source.

Yes, Cheniere Energy is in an amazing situation now, but it does have its risks. It's currently facing a large debt load, but has received $2 billion financing from Blackstone, and is currently in line for $4 billion financing with banks for expanding its facilities. Unfortunately, Cheniere Energy is heavily leveraged, which exposes it to unique risks. In my analysis, the benefits outweigh the risks. Not only are we experiencing extremely strong global demand, but we're also experiencing strong political pressures domestically to make America the energy exporter of the world. In president Obama's recent State of the Union address, he explicitly stated natural gas as being our key to transforming America from an energy importer to an energy exporter.

We're in a perfect trifecta:

1) Large oversupply met by stagnating domestic demand has led to a natural gas price freefall.

2) The global economy is picking up quickly and they need natural gas ... lots of it.

3) Strong domestic political pressures are creating the foundation for natural gas to replace oil.

Also, Cheniere Energy's stock is at an attractive buy in point of $11.86, since Monday's close, representing a 37.32% drop from its 52-week high last month. I bought LNG as it plummeted, starting at $13.94 and picking up more shares at $11.95.

Cheniere Energy's stock has depressed as investor panic about Europe, China, and India spread; leaving many speculating another global recession; however, we've seen some strong signs of economic improvement, which should maintain itself throughout the years to come. Unfortunately though, the situation in Europe is extremely fragile and will have an adverse effect on financial and energy stocks; especially on Cheniere Energy which relies on a strong future global economy.

I've stated this before, and will state it again. Cheniere Energy's stock is extremely volatile and can swing violently in both directions. Consider the investment if you have a very steep risk tolerance and can stomach drastic price volatility and uncertainty. I'm going to hold onto my shares and keep a sharp eye on the global economy; especially on China and Europe.

With exporting natural gas, we'll experience upward pricing pressure benefiting domestic companies like Chesapeake Energy (NYSE:CHK), Baker Hughes (NYSE:BHI), and Apache (NYSE:APA).

Chesapeake and Apache

In my opinion, Chesapeake Energy has been battered too severely with recent situations regarding its CEO and liquidity issues, bringing it to a P/E of only 7.28. Apache has a diversified portfolio of gas and oil plays and is also undervalued at a P/E of 7.68, forward P/E of 6.28; however, Apache has a much healthier balance sheet and isn't in short or long-term liquidity risk, like Chesapeake is currently facing. Both companies will benefit tremendously from an uplift in natural gas prices, which will come from the increased domestic and global demand, also helped by the decreased production of natural gas.

Amazon

Over the years, Amazon has experienced absolutely tremendous revenue growth, growing an outstanding 33.8% quarter-over-quarter. With all this growth, we would expect to see similar growth in earnings; however, earnings are actually on a decline, declining 36.4% quarter-over-quarter. Before displaying what my analysis concluded, I'll lay the framework for why I took this certain approach.

Whenever a corporation increases its revenues, certain variable costs associated with that revenue have to increase with it. To simplify things, we expect that when revenue increases by 1% that its operational costs increase by 1% (though segmented operational costs increase at different rates). I calculated quarter-to-quarter analysis of the percent increases in revenues and associated costs. I did this to see how well Amazon was managing its costs, and these were my results:

Cross-analysis between 2012/2011 income statement:

  • Net sales: +36.36%
  • Cost of Sales: +31.8%
  • Fulfillment: +51.5%
  • Marketing: +46.8%
  • Technology and Content: +63.21%
  • General and Administrative: +50.38%
  • Other operating expenses: +39.4%
  • Total operating expenses: +36.27%

Notice how the total operating expenses increased nearly identically with net sales, but that doesn't help us much in finding what's hurting Amazon's income. The variable expenses show that Amazon has been unable to keep its costs under control under Fulfillment, Marketing, and Technology, but because of the nature of marketing and technology expenses and their unpredictability, we'll put them aside for now. This also makes sense because their total expenses only shadow Amazon's fulfillment expense.

So, what is fulfillment? It's all the logistics behind getting your order to you, from the point of sale to the point of delivery. Since Amazon isn't a value-added intermediary, but rather, a supply-chain system, making this fulfillment process efficient is crucial to Amazon's long term success. Essentially, Amazon profits from keeping this particular cost as low as possible to optimize its earnings; unfortunately, they've been doing a poor job at it.

We would expect Amazon's fulfillment expenses to increase with sales, but at a lesser rate; essentially, if revenues increase by 10%, we expect fulfillment expenses to increase by less than 10%, which would signify an expertise on Amazon's part on keeping these costs low. From what we've seen, a 1% increase in revenues corresponds to a 1.42% increase in fulfillment expenses, which, in my opinion, is a troubling sign.

Also, a second very crucial thing to note is Amazon's earnings. Amazon's recent quarterly report was absolutely terrible. Its stock experienced a massive 15.75% appreciation from Amazon "beating" estimates; however, these estimates were so low that they weren't difficult to beat. In the case of Amazon, let's avoid doing an analysis on how Amazon performed relative to estimates, but rather an analysis of Amazon to itself. Although Amazon "beat" estimates, it's quarter-to-quarter earnings dropped by a brutal 36.36%, but from further analysis, I realized that it's actually much worse than it appears on the surface.

Amazon's core net income, after taxes, was actually $41 million and not the widely accepted $130 million. If you take a look at the income statement, there was a very large increase in income due to an "Equity-method investment activity" which increased the income by $89 million. Historically, this figure has ranged from (-20,+15); though there have been severe losses in previous years. Essentially, Amazon's equity investments are 20-50% stakes it has in other companies. Since the stake is so large, Amazon has to report the other company's income as its own, rather than traditionally reporting an appreciation or depreciation of its equity investments portfolio.

In my analysis of Amazon's true current situation, I saw value in calculating Amazon's actual earnings per share, excluding this subsidiary income from affiliate companies. I did so because, from a statistical standpoint, the very large increase in equity-investment income throws off most people's analysis. After excluding that income, I came to an EPS* of actually $0.09/share. It's true that the $89 million is considered as Amazon's income, which is why I'm not going to put much weight onto the $0.09 EPS* calculation excluding that figure.

What really pushes my reason to avoid Amazon's stock comes from a combination of factors. Although Amazon is experiencing large revenue growth, it's also experiencing a drastic reduction of its profit margin from 2% to 0.9%. Also, its current valuation is completely absurd at a P/E of 179.08; even if investors are accounting for large future growth, Amazon's current valuation is unsustainable. This is one of the few stocks I would claim as being in bubble territory. Even accounting for large future revenue growth, the forward P/E is 88.61, which is still ridiculously overvalued.

Finally, what put me off is Amazon's PEG ratio of 5.79, which signifies that its stock is currently severely overbought. The PEG ratio is a useful metric in determining how well valued a company is. It's calculated by dividing the current P/E ratio by the future 5-year earnings growth rate. As a rule of thumb, a PEG of 0-1 signifies an undervalued company, while a PEG ratio above 1 points to an overvalued company. Now, think for yourself where 5.79 stands at. This also points to unsustainable bubble territory.

Recently, Amazon has implemented a new fulfillment process with Kiva Systems - a process already utilized by Zappos, which has shown very favorable results. This will drive down Amazon's fulfillment costs, but results won't begin until Q3 2012. This will be something to look forward to.

Ultimately, I see Amazon's current valuation as unsustainable, and believe its stock is overweight. I hate to do a "history repeats itself" assessment, but I believe a review of it would be helpful.

E-Trade (NASDAQ:ETFC): Prior to ETrade's stock collapse, it was trading at a Trailing P/E of 171.73

America International Group (NYSE:AIG): Though AIG's stock collapse was due largely to unsystematic risk (risk unique to the firm), its P/E ratio of 443.11 definitely contributed to its stock's free-fall from $1233 to a low of $6.01 within 2 years.

Netflix (NASDAQ:NFLX): I view Netflix as being very similar to Amazon. During its peak, before the crash, it was considered a "perfect" company with constant double-digit revenue growth. Prior to its collapse, its P/E was at 105.5.

The overarching theme is that even though corporations may have very large projected earnings growth, if the stock is experiencing a dangerously high P/E, then it will correct itself. Amazon is trading at a P/E of 179.08 with a forward P/E of 84.68, which is still overvalued. In my opinion, stay away from this stock.

Note: Amazon's core EPS is calculated excluding income from large equity investments in affiliate companies and is not part of GAAP standards. It is used solely to isolate Amazon's core income from an analytical viewpoint.

Salesforce

"Salesforce.com is the leading provider of hosted customer relationship management, or CRM, software services. The company is expanding the breadth of its services and aims to be a multiapplication on-demand company. Salesforce.com has more than 100,000 customers worldwide, and derives more than 30% of its revenue from overseas sales" (Morning Star).

Customer Relationship Management is a justifiably growing trend in business as competition not only intensifies domestically, but globally as well. We live in a world where consumers are calculated by their lifetime net present value to a business; extending the scope of business transactions from simply "making the sale" to creating a lifetime customer. As a result, customer relationship management has become paramount in retaining and growing a company's loyal consumer base to secure a lifetime of transactions.

With the growing emphasis on CRM, Salesforce.com has sprouted and quickly gained a lasting presence in the market; however, their competitors are plentiful. Competitors like Microsoft (NASDAQ:MSFT), Oracle (NYSE:ORCL), and IBM (NYSE:IBM) have quickly gained traction in the CRM and Cloud markets, actually generating consistent profits, unlike Salesforce.

So far, the strategy employed by Saleforce's CEO has been: maximize revenue and market share, then focus on bottom-line profitability. Essentially, he thinks profits will flow simply by having the greatest market share and tremendous revenues. That theory is extremely flawed, illogical, and will drive Salesforce to the ground if it isn't changed soon. Also, Salesforce has shown an inability to generate maintain profitability amid the rapid revenue growth.

In fiscal year 2010, Saleforce's cost of sales comprised 19.7% of total revenues, leaving a generous 80.3% gross income; in 2012, their cost of sales comprised 21.6% of their revenues, leaving a decreased 78.4% gross income. Though they experienced increased top line expense control, their operational expenses went out of control. In 2010, it represented 71.4% of sales and became more dismal this year, representing 80% of sales. Essentially, Saleforce's motto is "we'll increase profitability after increasing revenues", but we've seen their profitability reverse with an increase in revenues. They're unable to manage their increased operational costs, which far exceeds the revenue it generates, leading Salesforce from having a profitable business in 2010 to becoming a money hole in 2012. Until I see management display an ability to control costs and generate profitability, like promised, then I would stay away from this investment. Yes, Salesforce provides a phenomenal service which can greatly benefit its consumers; however, they're unable to generate profit from doing so, making it a dangerous investment.

Salesforce has also experienced tremendous support from Wallstreet over the past year, pushing its price target to $164.10; however, these analysts are responding to personal incentives. Salesforce has an immense 99.69% institutional ownership, which is nearly unheard of. The very same institutions holding Salesforce's stock, and even the executives themselves, have been selling off their holdings while raving about the company's future profitability and equity undervaluation. Personally, I won't take advice from the institutions who own 99.7% of all the shares, whose true incentives are clearly for themselves.

Side Note

I dislike the disparity of gains/risks associated to shorting a stock. At most, the stock tanks to zero and you've made 100% on your investment; however, what's to stop a stock from experiencing extremely rapid price appreciation even if it's fundamentally unwarranted? As a result, your maximum gain is 100%, but your maximum loss is, theoretically, infinite. As a risk-averse investor, I avoid shorting stocks and, instead, simply stay away from them.

We experienced a very troubling sign on Monday as markets which were supposed to rally on the Spanish bailot, reversed themselves instead. Investors have begun losing confidence in Europe's ability to protect itself from an economic meltdown, which has led to tremendous market volatility, with likely violent swings in the future. My advice is to create a comfortable buy-in price, and don't be hesitent to bet 5%,10%,15% below current market values. We may see them come as waves of panic grip investors again, and again, and again.

Disclaimer: Please read my standard disclaimer for my articles here.

Source: 4 Stocks To Consider Investing In And 2 To Avoid