One of my worst investment decisions of all-time, and also one of my worst outlooks of all time, was by far Travelzoo (NASDAQ:TZOO). Back in 2011 when the stock was falling off a cliff from its all-time highs of more than $100 I was saying to anyone that would listen that, "TZOO is fine," and that, "TZOO is the next Priceline (NASDAQ:PCLN)." Meanwhile, Travelzoo executive Ralph Bartel was selling stock as quick as he possibly could, taking nearly $200 million off the table, which should've been a major indication of the future. I remember specifically at $55, when I really started my "pro-Travelzoo campaign", thinking that it was impossible for this stock to drop any lower. Looking back it's actually quite embarrassing.
If there's anything good that came from my favoritism toward TZOO, it was that I pledged to never buy another momentum stock, or a company based on the internet. I don't mind buying a company that has increased significantly in value, but I try to stay away from companies that trade with large valuations above fundamentals. However, following the earnings results of Mellanox Technologies (NASDAQ:MLNX), I bought the stock at $90, and have found myself fighting the urge to defend its recent decline. Is MLNX a second coming of TZOO? Is this a situation where I should learn from my past mistakes? Or is this company and its valuation different?
By now most know the story of TZOO: it rallied big in 2011 due to two strong quarters but has since retraced and has failed to live up to the high expectations once touted by the company's CEO and its board members. It is one of those stories where you sit back now, one year later, and ask yourself, "what was I thinking!" I am not suggesting that it's a bad company, or that it doesn't present value from its current price, but back in the first half of 2011 the stock was simply way too expensive for its fundamentals.
I suppose if we're trying to determine whether or not MLNX will experience a similar fate we must acknowledge that it trades with a massive valuation, and has pulled back by 15% during the last three days alone. The company is not at quite a "Travelzoo" valuation. Mellanox trades with a P/E ratio of 80 and a price/sales of 12.69, which is still nowhere near the valuation of TZOO at $100.
The big question for Mellanox investors is if the stock is too expensive? We already know that it's growing fast, but after its recent pullback could it see a steep downtrend, similar to Travelzoo? The company's performance has been impressive. It has increased in value by 250% over the last year alone, and over 475% over the last five years. In its recent quarter the company easily exceeded Wall Street's expectations with a 267% increase in EPS and a 111% rise in revenue year-over-year. Such results impressed me, as I purchased shares at $90, because although expensive with a P/E ratio over 80 and a price/sales of 11.64, it still has great growth prospects with a diversified business in a growing segment along with its impressive sales of the InfiniBand. Its growth is expected to continue, as the stock has a forward ratio of 24.83, meaning it may not be so expensive.
Like all momentum stocks, there are strong opinions on both sides of the trade. The stock has slid 15% over the last few days following a series of events which was sparked by a downgrade at Stifel to "Hold". Fellow Seeking Alpha writer Kerrisdale Capital added to the decline of the stock, by arguing that sales of the company's InfiniBand adapters will slow, or fall, in 2013 as a server upgrade cycle, centering around Intel's (NASDAQ:INTC) Romley Xeon CPU's, winds down. Kerrisdale made some very compelling arguments and discussed additional competition that will affect the company's aggressive growth. Of course this is speculative and is the opinion of one firm. The company has responded in saying that InfiniBand won't face serious competition from rivals for at least three years, and also reiterated its relationship with Oracle (NYSE:ORCL).
Unfortunately, the series of events that led to the decline of MLNX caused my stop-loss order to be executed at $110, leaving me with a decision of whether to be happy with profits or to reinvest in the company. I ultimately decided to reinvest at $100, a price that I believe to be fair for a company that is growing at this rate. However, I do acknowledge that competition could arise, and seeing as how the company prefers to remain independent I believe the long-term substantial upside in the stock may be limited. With that being said, a forward ratio of under 25 is cheap for a company growing at such an excessive rate. Therefore, it is a stock worth watching. It has not yet become a "Travelzoo" because, despite being expensive compared to current fundamentals, the market is still large for its products and I think MLNX has created a strong presence in the space. At this point it could go either way, but its short-term upside far exceeds the downside, which in my opinion separates it from Travelzoo, as anyone with an open eye could've seen that TZOO was overvalued at $100. With MLNX, the value to growth relationship is not so clear, and there could still be substantial growth ahead.