Five months ago, I provided five futuristic, imaginative picks to exploit the market's fearful, reactionary preoccupation with "value" and familiarity.
With today's zeitgeist favoring conservative stocks regardless of context, the market has turned its attention away from growth and imagination.
I put together a basket of stocks that are higher in price relative to backwards-looking fundamentals. These stocks have technologies woven into their business models, producing investments which are theoretically sensible yet practically unproven. This grey area in combination with an overly fearful market allows a discount in share price.
The picks have overlapping relevance across energy, transportation, media, and health. These are high-risk stocks which allow for high reward; however, this makes diversification necessary. Clearly this basket alone is not a full portfolio.
Here are my five recommendations from the article:
- Lightbridge (LTBR) (Energy)
- Tesla (TSLA) (Transportation, Energy)
- Digital Domain Media Group (DDMG) (Media)
- Google (GOOG) (Transportation, Media)
- Pluristem (PSTI) (Biotech)
I disclosed a long position in Pluristem. I did not suggest weighting any company above another. Here is a chart of the price performance since:
LTBR data by YCharts
Pluristem has been the only win. We see varied movements for an equally weighted paper loss of 5%. Let's run through a description of the companies, and what has happened in five months. Then let's consider the general market situation going forward.
Not all unproven investments are appropriate for this basket; the investment must meet fundamental needs, have attractive scaling potential, have superior moat, and have an explanation to accompany the appearance of undervaluation.
Fukushima put a question mark next to nuclear; however, the economics of base load electricity need, nonrenewable material supply, global power-consuming middle-class growth, and carbon emissions provide sturdy rationale for betting against the question mark. Nuclear power itself satisfies a fundamental need.
Lightbridge is an intelligence-based nuclear company that was advocating for safer (passively protected) designs before Fukushima happened. So the stock should have moved up after stupid danger was exposed in Japan's reactor. Had Lightbridge designs been used in Fukushima, the disaster may not have happened the way it did.
Still, the company is trading lower with all nuclear stocks because the company currently derives revenue from consulting newly nuclear countries. And, Lightbridge has a small market cap which in today's market is categorically bad.
Enthusiasm for new nuclear has clearly faltered in the short term so traders have correlated this with Lightbridge's consulting value. This is correct from the perspective of how the stock has been trading, but ultimately inappropriate given Lightbridge's focus on non-consulting investments.
Over the next few years, the patented technology currently being brought to market will begin to see its deserved weight in stock price, and consulting revenues will take a backseat. Although there is no expectation of falling consulting revenues, the opportunity for the patent licensing is much bigger.
As CEO Seth Grae mentioned in a recent earnings call, many employees take compensation in stock because they see the opportunity is only a few years away. Then again, for most stock pickers, a few years is an eternity, and nuclear tech is understood by a very limited number of individuals. I wrote 5 months ago:
Management includes top specialists from international law, nuclear engineering, and future corporate customers. The target market is in the low billions, and the market cap is in the low tens of millions.
If -- and when -- this inceptuous technology reaches adulthood, the stock should move easily past 9 times its current price.
I believe that a combination of factors has resulted in severe undervaluation of Lightbridge, creating a buying opportunity:
- Overreaction in market to socio-political nuclear panic
- Unrealistically optimistic expectations for alternative energy
- Exodus of funding from micro-caps over the last couple years
- Insular community of experts, mystique of nuclear tech limits investor awareness of nuclear design
- Multi-year time horizon is unattractive to most traders
The stock has lost money in the last few months because it continues to attract a limited demographic of investors and hasn't put out any big announcements.
In the short term, there is a potential catalyst of new consulting contracts -- which management has hinted at. In the long term, the investment thesis remains the same: Lightbridge has a monopoly on a modular nuclear upgrade which will produce higher output on sunk costs while increasing safety.
We're talking about 200% ROI for Lightbridge's customers with deals in the tens of millions for the average client. This should bring the stock price up more than tenfold by 2018 if not before.
On the latest earnings call management reaffirmed the unlikelihood of immediate dilution. The company has a strong cash position for its activities, and no worrisome debt. It continues to trade around 10x historical revenues, meaning an investor can enter now and get the intellectual property -- the essence of the company -- for virtually nothing.
Tesla's chart since 2010 shows linear upward direction, so this pick is not entirely contrarian. The contrarian attribute exists in that the stock price does not fully reflect the planetary scale of Tesla's potential market. Also, it has lost money since I picked it because analysts don't believe earnings are going to grow like the company claims they will.
I like Tesla because it is a fundamental-need, resource-level energy play: a new category of vehicle, something that is electric and asks the consumer to make no sacrifices. The long-term plan is for the cars' price point to look less like a Benz and more like a Prius. The automaker is rooted in Silicon Valley, and it is taking oil to electric like analog went to digital.
Over the long-term for this stock, it has been moving up in price because nothing has gone wrong yet, and it will continue to move up until something big goes wrong in the continued scale-up. So this dip is an attractive entry assuming continuance of the nothing-goes-wrong paradigm.
Look, I think Tesla is kind of silly right now for consumers. I read an article about a Berkeley grad listening to Walden on tape in his Tesla, and thought nothing could be more pretentious. I include this tangential paragraph to establish that I am somewhat repulsed by the product and in turn I think this strengthens the credibility of my attraction to the company.
Because it doesn't matter what I think is cool or reasonable; Tesla is selling and will continue to sell. As much as I hate the idea of being a Tesla owner, when the price comes down and driver-less cars are commercialized, I will probably buy a Tesla and read Fredric Jameson's The Modernist Papers in it to honor the company's heroic journey against the status quo of engineering.
One of my friends at a hedge fund, who helped me with another idea, has been stressing the uncomfortable lifestyle changes that Americans and Westerners will have to make in our transportation habits. But Tesla (and nuclear) is the alternative to breaking our global car -- and oil -- addiction. Always bet on addiction!
We see the footage of Fukushima with the Japanese wearing masks to avoid nuclear pollution, but what we don't see is: every day, around the world, millions of people inhaling CO2 as they seek upward mobility in crowded cities.
Electric cars aren't just for San Francisco intellectuals sporting elbow patches listening to Malcolm Gladwell while driving to a wine tasting. They're for the families in developing nations who live within stone's throw of freeways, receiving a constant breeze of smoke. Not all of them will have cars, but all of them will benefit from reduced emissions.
The market for Tesla is misunderstood, but so is the basic science. It is usually bad for lawyers to tell physicists about physics, like the resident Tesla bear here at Seeking Alpha. I am decent at separating physical feasibility from fiction and I don't see any reason to doubt the physics of Tesla.
This is a problem in the stock market. Part of being responsible intellectually is respecting (if not revering) experts. The engineers should be more humble in their talk about legal issues like Vringo (VRNG) litigation, and the lawyers should be more humble in their talk about engineering. But, people aren't doing what they should be doing and misinformation creates advantages for discerning gamblers. Bet against bad info.
Qinect crunches the numbers here and concludes bullishly [emphasis added].
The company has maintained its 2012 outlook, despite downward revisions from Wall Street. The company expects $560 million-$600 million sales this year, around 15% more than analyst estimates of $480 million.
With favorable reviews for the Model S, an increase in its demand from 11,500 to 12,200 units in just 15 days, plans of expanding production facilities, availability of easy credit to tackle negative cash flows, a more bullish management, and its expectation of breaking even cash flows by the end of the fourth quarter, TSLA seems an attractive opportunity to buy.
The earnings pattern tells us that the company is expected to start making positive earnings in 2013. Trading at a forward multiple of 48x, using the 2015 earnings the stock is expected to trade at $50, which means an upside of more than 100%.
Here's why Tesla fits with this basket of undervalued companies:
- Misunderstood as a high-end product when it's really going mainstream
- Meets a fundamental need with a huge market
- Strong head start in technology creates moat
- Relatively weak brand recognition outside of Wall Street has resulted in less hype around the stock, because the car is just beginning to become known to the public. hype will grow
- Disparaged as unrealistic scientifically despite a lack of corresponding intellectual authority to justify this accusation
Digital Domain Media Group
Put simply: Digital Domain is a servant who went into debt to become a master. It is now a slave to the perception of financial sterility. The company served many of the most successful movie makers of all time, providing leading digital visual effects but taking a flat fee. Now it's making the financially demanding transition into equity ownership of its projects. Hence, a less than ideal (but improving) ratio between money coming in and out.
Although producing an incredible Tupac hologram since my pick five months ago, the stock has slipped into "microcap hell" due to a lack of investor interest. This highlights the importance of diversification, because without risk there is no reward. It also means there is a stronger contrarian opportunity for stoics who enter at this point.
I saw Michael Burns of Lionsgate (LGF) on CNBC a couple months ago talking about Ender's Game, which is DDMG's first equity stake in a movie. See the four minute mark. He was coming off the success of Hunger Games and referenced Ender's Game as potentially "the next thing". This confirmed my opinion. Ender's Game will yield a healthy boost to earnings next year, but more importantly will serve as a proof of concept for the ownership business model. The stock market is uncreative and values companies based on acceleration of earnings, so it is not difficult to predict an upward inflection point at the successful release of the A-list film.
A comparable but inferior company called The Mill was acquired for a couple hundred million, meaning Digital Domain's enterprise value is currently trading no higher than its worst-case takeover price.
Recent earnings showed 48 percent revenue increase over last year. GAAP net loss to common shareholder came down from $4.52 per basic share to $0.86. The losses come from the expenses of establishing ownership stakes; the legacy business of non-ownership projects remained strong, with the commercial division growing 175%.
An internationally prominent hologram news story, an ownership agreement to reincarnate Elvis, licensing of 3D IP, and strategic placement of cost-lowering initiatives show the company gaining traction in everything except its investor base. This captures the essence of exploiting the value investing bubble with a futuristic investment.
- The innovative leaders in creating visuals digitally
- A new business model just gaining traction
- A stock that conventional wisdom is skeptical of
- A globally positioned play (Abu Dhabi, China)
- Clear Ender's Game catalyst in 2013
- Quiet ongoing success and synergies in legacy/work-for-hire business
It has been said that a "flight to quality" in tech stocks has lifted Google. Meanwhile Apple (AAPL) has touched an all-time high. I liked Google more than Apple and I continue to. I think Google remains discounted given its future potential. It is discounted because it requires imagination.
Like Digital Domain Media Group, Google has a legacy business. This is a search engine with pay-per-click advertisements. But Google is betting on a more tangible wave of consumption in augmented reality devices; like Digital Domain Google is a company in transition and expansion.
People thought Google bought Motorola just for the patents to protect Android. But actually, execs have said Project Glass, an original device, is a primary bet for Google's future. Motorola resources were used for Glass. So analysts deeply underestimated the ambition of the handset acquisition. They underestimated the Jobsian focus of Sergey Brin in bringing Glass to reality.
It's time for analysts to stop projecting the inferiority of most tech companies onto Google. Google has proven its unique ability to transcend niches and skill sets. And it has proven its ability to make money from its think tank: look at the purchase of DoubleClick. It's one thing to make great inventions; it's another thing to monetize them, and Google does this well. Yet Google is still young and hasn't begun to see its true market cap potential.
Ryan Holiday, media thought leader and author of "Trust Me, I'm Lying," recently named Google as his favorite stock idea in a conversation with me.
I actually still like Google. Not because of Plus or the social media component but because they finally professionalized their ad sales operations, and they've made huge gains in display, mobile and tablet ads. At the end of the day, (client servicing is) where the money is-television companies are essentially excellent client services businesses -- think: upfronts -- and Google is catching on and playing that game well.
I like Google for driver-less cars, the efficiency of its API and services, Project Glass, its leadership, its AI technology, and its ethos. Its P/E of 19 is quite reasonable for a leading tech innovator. I also like how its business model of selling ads allows it to circumvent monopoly regulation.
It fits in this basket due to:
- Being exaggeratedly vilified and misunderstood as having problems with privacy, shareholder voting dilution, lack of focus, and being only a search engine
- It is popular, but not hyped like Apple (For example Business Insider, a top tech business newsbreaker, is run by an Apple shareholder)
- Strategic, tangible potential to profit with driver-less cars, Project Glass, and other futuristic developments are not priced into the stock so much as the stock trades on legacy business growth
I took a deductive leap with this Israeli biotech. One, there was the potential for many future developments for billions of dollars of drugs. Two, there were confirming signals from credible sources that showed the technology could be more than hype.
Pluristem develops, licenses, and manufactures stem cell medicine in 3D using afterbirth cells. The treatments are one of few known approaches that may, before 2020, improve the condition of patients suffering a wide array of common diseases. Research and development funding in biotech is cautious now, and this creates buying opportunities. Somewhat early in approvals, Pluristem is still a raffle ticket, but it's a ticket I'm happy to pocket for a deep discount.
Recent developments have strengthened the message of these signals. It has renewed a 5-year partnership with a German research facility, received Phase II trial go-ahead from India for Beurger's disease, saved the lives of two distinct patients with emergency PLX cell infusion, and added new indications to early pipeline with major potential markets.
Seeking Alpha is the leading media outlet for analysis of this company. This includes exclusive articles from the CEO that readers had access to before the latest pop. Take an hour, sit down with a coffee and read them. There are too many details to include here.
Pluristem is developing stem cell technology. My argument has been that Pluristem's flexibility will lead it to profitability. Despite the runup, there is ample room for price appreciation. This stock is not particularly misunderstood because most people don't even look at individual biotech picks. Pluristem belongs in this basket because of its deep future potential across a wide, flexible range of conditions.
Pluristem is flexible because:
- The source of cells (placenta) is non-controversial (unlike embryo)
- The mechanism of action empowers the body to heal itself (passive engineering)
- It offers treatments that can be applied "off-the-shelf" (modular design)
- Its intellectual property spans multiple categories of disease and is reliably defensible, even within biotech's changing legal framework
One may invest in these with equal weight. A contrarian with a multi-year horizon would do well to buy extra Lightbridge and Digital Domain, in my opinion, and rebalance if and when they mean-revert. A well-diversified portfolio will have far more than 5 risky picks, of course.
The market continues to be unimaginative and under-value these companies. These are contrarian picks and it's not a surprise that the immediate market moves against them. But, facts always wake the market up over the long term. A disciplined investor can win the staredown.