You Heard It Here First, Part II

February 19, 2007

Barron’s agrees with the Stock Geek, again.

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Here’s What I know

February 14, 2007
  • I know robots are here to stay. Exchanges are using them to cut costs and improve efficiency, doctors are using them to do surgery (isrg). They’re even cleaning our floors for us and picking up bombs in Iraq, but by iRobot’s (irbt) stock performance you couldn’t tell. Who makes the robots that make cars? We all know that people are leaving the assembly line…
  • I know that goods are moving around the world, to every corner of every market. UPS (ups) should benefit from this, as should Expeditor’s Int’l (expd). This story isn’t going away any time soon, the growth in emerging market’s and increased outsourcing/offshoring will mean that every thing from gold to oil to Dell computers are being shipped overseas as we speak.
  • I know that the global investment market is strong, both for professional’s and “retail” investors. Look at FactSet (fds) to see the strength in the investment bank (not to mention Goldman Sachs (gs)). Did anyone see the strength in Schwab (schw) recently?
  • Emerging markets show no sign of slowing. Look for those who supply both what the citizens of these markets need and want. For the former, look at AES (aes), who supplies power in 26 countries. For the latter, look at NII (nihd), which is Nextel International, a major cell phone provider in Latin America. Also Turkcell (tkc) is a good play on the growth in the middle east.
  • Internet valuations are more than twice the market’s across the board. I think the best buy’s are the niche players who control their markets. Look no further than Blue Nile (nile) for online jewelry, Bankrate (rate) for online mortgages, The Knot (knot) for weddings, and CNET (cnet) for tech news. I think that they’re the best positioned to benefit from ads moving online, not Yahoo! or Google. The Cisco’s of the world might be good too, but I don’t understand the business enough. Online brokerages, such as OptionsXpress (oxps) also benefit from the growth in broadband.
  • Companies are outsourcing everything but core competencies. Paychex (payx) and ADP (adp) are best positioned to benefit from the outsourcing of HR, and Cognizant (ctsh) and Accenture (acn) should win the IT war.

That’s it for now. Stay tuned for “Here’s What I Don’t Know.”  Any other themes you’re looking at? Tell me in the comments!

Full disclosure: I own shares in AES and OXPS. 


What’s the Market Missing?

February 10, 2007

That’s the question we, as small individual investors, always need to ask ourselves when we evaluate a stock. It is my belief that to be a successful investor, we need to do two things

a) Identify “good companies

b) Identify those which are priced wrongly.

I’ll use two examples from previous posts to illustrate this.

Yellow Roadway (yrcw): First step was indentifying it as a “good” company- I saw that even though the company floundered in the last slowdown, over periods of 5 and 10 years they grew very quickly (20% for 5 years, 11% for 10 years). Another thing I noticed was that their operating margin was higher than any other point in the last ten years, even higher than during the last growth-spurt of the US economy. Thats part a, step one, the numerical analysis. Part a, step two is the qualitative analysis. I looked into managements efforts to broaden their offerings to customers by acquirering competitors. They now have perform everything a customer can ask them, any truckload size, length of trip, time to delivery, etc. They also expanded into mainland China, which is growing far faster than the US. I am also encouraged by their move into the non-asset based logistics market through the acquisition of Meridian IQ. Non-asset based companies have higher margins and lower risks than asset based companies, such as Yellow Roadway (look at Expeditors International , expd,for an example) . After doing this research, I was encouraged by their efforts into margin protection during the next slowdown, and into growth oppurtunities via china, meridian.

Now we had to figure out if this was a good time to get in the stock. Yellow Roadway was down 40% from its 2005 peak, due to fears of higher interests rates and an imminent economic slowdown. Both of these factors are definitely concerning. I just thought that all bad news was priced into the stock . The stock, at around 5x cash flow, was trading at a deep discount to its historical average and competitors. In fact, JB Hunt (jbht) was trading at twice the cf multiple of YRCW. There was no reason not to buy at least a partial position of YRCW, with plans to add more when the stock was hit on economic-slowdown fears.

Circle is suggested entry point

Paychex: Part a) Is this a good company? Absolutely. Great, consistent returns over 10, 5, 3, and 1 year periods (rev. growth of 18, 14, 15, 16 per year, respectively). They perform critical services for clients, such as HR outsourcing, payroll, filing neccesary paperwork, managing funds… These definitely are not commodity services, companies, whether they are 3 people or 3,000, only will give this work to trusted, established companies. Paychex has the largest client base in the country, and a retention rate. They are expanding overseas and have goals to growth EPS over 15% over the forseeable future. Since they have such a diverse client base, a slowdown in employment growth wouldn’t significantly hurt them, nothing close to the impact it would have on a Administaff or Manpower. I have confidence that this business will grow and flourish in the future.

So does the market. And thats the problem. The stock trades at 25x cash flow and 30x earnings, which are both significantly higher than competitor ADP. The discount may be warranted, I just don’t know enough about the business to be sure that I’m buying a great company at a great price. Having just one of those two factors isn’t enough, we need both.


Warner Music-Why I’m Mixed

February 8, 2007

As you probably know, Warner Music reported another bad quarter this morning. Even though part of the decline was due to tough comparisons, a revenue-down-14% and income-down-75% way below expectations type of quarter. However, they were the only major music company to gain market share over the past year- a sign that the company is doing better than the industry. There were two other bright spots a) Japan–sales up 70% YoY and b) digital, up 45% YoY to 11% of sales.

I don’t see much happening with this company untill 3Q- when we know for sure about whether or not a merger with EMI is happening. Also the company stated that its a back-end loaded year in terms of releases.


An Update on Our Picks

January 30, 2007

Since I’ve been doing this for a couple weeks now I’d like to update everyone on some of the stocks I’ve written about.

On January 12th, I wrote about Netflix and how I think that the long-term story may be better than the Street percieves. Its down about $1/share since then due to some selling before earnings, and then a quick pop afterwards. They reported another big increase in subscribers and rapid growth in profits. What remains to be seen is whether more new subscribers will choose Blockbuster over Netflix which will hurt margins, lower prices, etc.

My January 15th piece on YRC Worldwide came right before a Barron’s positive article about the company and a Wachovia upgrade to outperform. Combine these two factors with recent data showing that the US economy is “trucking” along fine, and the stock has had quite a nice move, up almost $4 since then. I don’t really see any reason to sell this stock- investors still think that it’s cheap and I think that the risk/reward profile is heavily in our favor.

Electronic Arts hasn’t done much in the past few weeks. Recent concern about slow PS3 sales have hurt the stock a little, but I’d like to reiterate my position that any weakness should be used as a buying opportunity.

Both Paychex and Warner Music Group have stalled recently. I’m still researching these companies and will write more about them when I learn more…

So thats it for now. I’ll probably write about Blue Nile soon, I think its a great company.

-Da Stock Geek


Warner Music Group-Look Beyond the Headlines

January 25, 2007

To most people, when you say that you think that Warner Music Group (nyse: wmg) is a great investment, they’d laugh at you. But I wouldn’t. I love the idea. Warner was spun off from Time Warner (makes sense…) in may 2005. The physical side of the business, which accounts for about 88% of revenue, is declining, but the real “magic” in this company comes from the digital side (12% of revenue). Last year, digital, which comprises both ringtones and music on websites like iTunes, sales doubled. This is the real growth driver for the company, and the management knows this- on the last conference call they talked about their “laser focus” on the digital side and on signing new artists. Warner increased their digital market share by 300 basis points to 20.5%. The reason why digital is so important is because it has much higher margins than physical sale. The management team at Warner knows that the music business is changing rapidly, and they are insistent that they remain on the vanguard of the “music revolution.” They just signed a new deal to have their music videos published on YouTube. They also signed deals to have music video’s published on Google and Brightcove. Warner is also persuing strategies in international markets, with sales in Japan, for example, up 50% YoY.

I want to emphasize that there are many risks with Warner. Because physical sales are so important, price and unit declines will hurt the bottom and top lines. But, I would buy this stock on any weakness, because I think that the management really understands that technology is changing and they are moving this company towards faster-growing, higher margin businesses. Besides, they pay a 2.5% dividend yield while you wait.


Paychex-The Bull Story

January 20, 2007

You probably have heard of Paychex-they are the company who your company outsources their countless paperwork and staffing needs for things like 401(k) plans, HR administration, and payroll. A majority of their business comes from small businesses, who have no (or little) pricing power and time to do this stuff. They also act as a PEO, or Professional Employer Organization for larger companies, which means that they act as the employer and then lease the employees to the company.

These businesses all have extremely high barriers to entry, and as a result, the market is dominated by a small handful of larger players. Paychex has a 10% share in this market, which places them in “second place” to ADP, who has a 30% share. Paychex has 543,000 clients (98% less than 100 employees), which means that no single customer contributes a material amount of revenue, limiting risk if a client leaves. According to their latest 10-k, Paychex has a client retention rate north of 80%, with most of the attrition attributed to customers going out of business, not switching providers.

Paychex projects that they can achieve 15% income growth over the forseeable future, in line with past growth rates over 5 and 10 year periods. Right now they are trading at 30x past earnings, a 2.0 peg. The company’s share are expensive, but that is because they have such a wonderful business model, unique competitive advantages (a large moat) and recurring revenue from customers. As their clients grow, so does Paychex, and probably your portfolio as well.

I’ll be writing about this company and the staffing outsourcing industry as I learn more about it.