Bargains And Rip-Offs

The market’s pre-election volatility is proving opportune to those of us assembling a portfolio with a look at improving fundamentals. The bird’s-eye view is that earnings are quietly growing while prices are fluctuating around flat or sinking. Earnings season is not yet over, but the third quarter seems headed for an overall 17% increase. When earnings increase but prices stay constant or fall, values appear.

At some point, the market will recognize this imbalance and correct it. Some argue that valuations have been so rich for so long that most investors have forgotten what true value is. That’s a compelling argument and one that I’m inclined to agree with as a philosophical view of the world. I grew up watching my parents bargain shop to feed a family growing to an eventual seven children, myself being the oldest of the bunch. I paid for most of my own belongings and education with money I earned at jobs ranging from dishwashing to food delivery. I’m a bargain shopper at heart.

Still, one can’t ignore the fact that the market has risen against its own historic overvaluation for the past 20 years or so, depending on who’s version of overvaluation you use. Within an environment of an overvalued market that just plain stays overvalued, one can still find the occasional bargain.

That’s what I’m doing. That’s why I bought Maxtor yesterday at $3.25, some 70% below the January price at which SmartMoney recommended buying it. That’s also why I’m watching Sun, UTStarcom, and ProFunds Ultra Semiconductors for good buy prices. All are trading at low ends of their ranges over the past couple of years. See my October 20th article below for the prices I suggested.

I should also point you to my ever-present Dow portfolios. All three are down so far this year. The Dow itself is down about 7% and, true to form, my Double The Dow strategy is down almost 14%. This is the same strategy that returned 51% in 2003. The nice part about investing in the Dow is that it doesn’t stay down forever. It’ll be back. Now would be a good time to start your own Double The Dow strategy.

The market dropped today, but Maxtor rose nearly 2%. The bad news that drove it down was two-fold. First, its CFO quit after just two months on the job and that screamed “accounting scandal” to Enron-battered onlookers. On Wednesday night, the CEO and interim CFO assured listeners on the earnings call that the company’s accounting is fine and that the CFO quite for personal reasons. On that same call, however, listeners learned that earnings were down and that the market looked bleak going forward. Sound the alarm bells and tank the stock.

Two weeks ago — on October 7th to be exact — Maxtor traded at $5.85. Yesterday, it hit a low of $3.10. Have the company’s prospects dimmed so markedly in the past two weeks as to justify a 47% price cut? I don’t think so.

Maxtor makes hard drives. They’re used in computers and other appliances such as TiVos and PDAs. Look around you. Is the world becoming more digital or less digital? More, you’ll probably agree. As it becomes more digital will there be a greater or lesser need to store data? More, you’ll probably agree. Therefore, Maxtor’s description of itself says a lot about its prospects going forward:

As the world becomes more digital, the need for storing all that digital data increases. Maxtor offers one of the most pervasive lines of reliable storage products to store the digital world. Maxtor products are found in homes, at work, and in large enterprise businesses. Maxtor is everywhere.

Before we get too excited, it’s worth noting that the hard drive industry faces hurdles, mainly overcapacity. They’ve made and continue making more hard drives than the world is buying. But that’s not new. Indeed, the last few years have been hard on the tech market and Maxtor has managed to keep its revenues going the right way:

$4.1 billion, 2003

$3.8 billion, 2002

$3.8 billion, 2001

$2.7 billion, 2000

$2.5 billion, 1999

$2.4 billion, 1998

Where’s the problem in those numbers? I don’t see one. My take is that we have a situation where the market has overreacted to some genuinely troubling news. Yes, there are clouds overhead, but they don’t justify a 47% plunge in two weeks. Moreover, show me a time when deeply discounted prices accompanied happy headlines and I’ll show you an empty bottle of whiskey in your hand. Low prices don’t come from good news. Low prices come from bad news. Recent news has been bad and Maxtor’s price is way down. I bought and I’ll probably buy more.

I also suggested shorting Google at any point above $150. While I still think that will eventually prove profitable, recent euphoria leads me to raise the target price for shorting to $200. On strong earnings today, the stock rose 15% to $172 and is now double its $85 IPO price of just two months ago.

All this excitement led Prudential Equity Group analyst Mark Rowen to reiterate his “overweight” rating on Google and raise his price target for the stock from $130 to $200. From Reuters:

Rowen said his $200 share price target assumes a price-to-earnings multiple of 76 times his raised profit estimate of $2.62 per share for fiscal 2004, or 54 times his 2005 estimate of $3.67 a share.

It also assumes sustained 50 percent year-on-year compounded annual growth for Google to justify such a valuation in most investors’ lifetimes.

Rowen said he has valued Google at a lower level than its Internet peers — companies like Yahoo or eBay.

Yahoo, Google’s closest rival, now trades at 105 times Rowen’s fiscal 2004 estimate, he said.

Evidently it’s time to party like it’s 1999. If memory serves, there was one thing to do at the end of that party: short. Hence I reiterate my earlier suggestion to short Google. Instead of doing it at $150, let’s start thinking $200 instead. At its recent rate of ascent, GOOG should reach that price within the first hour of trading this Tuesday. Can you wait that long?

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