Don’t Get Distracted
Three High-Potential Stocks
The Problem with PE Ratios
As you’ve noticed, the world is falling apart.
Well, not really. In the vast majority of countries, the vast majority of people continue to go about their business as they always have. They work, they raise families and they pursue their dreams. But the media have become very skilled at showing images of the world’s most troubled environments, from starving children in Ethiopia to burning vehicles in London to moaning stock traders in New York, and the result is that some investors get distracted.
They think--or feel--that this time it’s different (as if we live in a Special Time). And so they leave behind the time-tested rules about investing and start to wing it. And you know how that story ends!
So my message today is to remind you that throughout the course of history, markets have fluctuated, and those investors who’ve achieved their goals are those who’ve stayed the course and continued to follow tried and true investing systems. They haven’t been distracted. For growth-oriented investors, this means buying high-potential growth stocks with strong charts, and holding them as long as they remain strong.
Of course, not all environments are suitable for buying. At times like the present, it’s better to do research, to work on your watch list and prepare for the more supportive market that lies somewhere ahead.
In that spirit, here are three young high-potential stocks. They’ve all come public fairly recently, so institutional ownership is still low and the number of potential buyers is huge. They all have substantial trading volume. And they’re all changing the world for the better in fairly revolutionary ways, which means not only that these companies have major growth potential, but also that their stocks offer major profit potential to early investors.
LinkedIn (LNKD) is a networking site for professionals, sort of like a Facebook for grownups. I’ve been on it for years, though I can’t say it’s changed my life the way companies like Apple and Netflix have. Still, the company is thriving! It has more than 100 million registered users in 200 countries. Revenues, mainly from advertising, have been growing at a good rate since 2006; they grew 102% in 2010 to $243 million. Earnings trends are good, if uneven. And the after-tax profit margin last quarter was 8.9%.
LNKD came public in May at 45, peaked at 122 that first week (a sign of froth), and then declined to establish real support at 60. That was followed by a surge up to 115, a correction--in the big market sell-off--to 73 and now the stock is back up above 90. All things considered, it’s a good--though young-- chart. If you think LinkedIn might change the world, put LNKD on your watch list, and try to get on board before it breaks out above 120.
Tesla Motors (TSLA)makes high-performance electric cars. It’s already sold more than 1,840 roadsters, priced at $109,000 each. Next year it expects to begin selling a sedan that seats five adults, for about $58,000. And sometime after that, it expects to produce a model that will sell for about $30,000. The company hasn’t turned profitable yet; the business is simply too capital-intensive in these early years. But it’s well funded and management is top notch; Elon Musk, the fellow who started PayPal and sold it to eBay for $1.5 billion, founded the company. As electric cars improve, I expect Chevy, Nissan and Toyota--to name a few--to compete for the low end of this market, but Tesla’s uncompromising dedication to vision--as well as its freedom from the legacy issues that plague older automakers--may allow it to lock in the top end.
As to the chart, Tesla has been public since June of 2010. Its uptrend is clear, as is resistance at 36 and support at 21. The recent pullback brought the stock down to 23, but it’s firmed up in recent days and is a tempting buy here for investors with long time horizons.
ZipCar (ZIP) operates a car-sharing network, offering more than 8,000 vehicles in 28 North American states and provinces. Members reserve cars online or by phone, and use their membership card to enter the reserved car. Members pay as little as $7.50 an hour per car. They can drive a Prius one day and a pickup truck the next. And it all takes place without human contact! ZipCar’s revenues have grown every year since the company’s debut in 2005; last year they grew 42% to $186 million. And while the company is not yet profitable, analysts estimate it will earn nine cents per share in 2012. I think it’s an idea that can go far.
As to the chart, ZIP came public in April at 18, topped at 32 on the first day, and bottomed at 19 in June. Since then it’s been building a base at the 20 level, and even the market weakness of the past two weeks hasn’t pushed the stock below that support level. That’s impressive!
Finally, a note about valuation. Many investors schooled in traditional value investing will look at these three stocks through the lens of price-to-earnings (PE) ratio and conclude that they’re too expensive. LinkedIn has a PE of more then 300. ZipCar is trading at 240 times next year’s earnings. And Tesla may not make money for years!
Now, PE ratios are a useful tool (among many) for evaluating older, slower growing stocks, like Abbott Labs (ABT), Aetna (AET) and Archer Daniels Midland (ADM), but they’re fairly worthless when it comes to evaluating companies with great growth prospects.
Investors who were constrained by the “common wisdom” of PE valuation missed the great growth phases of Microsoft, Dell, Cisco, Amazon, eBay, Google, Crocs and dozens of other fast-growing companies. And investors who remain constrained by PE will continue to miss the greatest growth stocks.
And there’s nothing wrong with that if you want to be a value investor and focus on larger, older, slower-growing companies.
But if you want to hit home runs, you’ve got to swing for the fences, and that means investing in young companies with great potential to grow rapidly, like the three companies above. I’ll be keeping an eye on them in the weeks and months ahead and I hope you will, too.
Yours in pursuit of wisdom and wealth,
Cabot Wealth Advisory