Mellanox: One Foolish Question for Those Who Sold on Thursday
Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
How much is a $3 million miss worth to you? If a company were to announce that it expects sales between $145 million and $150 million, but is “expected” to announce sales of $153.1 million then how much of a loss does this “miss” warrant? Keep in mind, this is just guidance, this particular company has a long history of crushing its own expectations. Therefore, think about it, would you sell stock in such a company, and how much of a decline would this warrant?
Before answering the question, let’s add a few more factors to the equation. First, the company we’re referring to is Mellanox Technologies (NASDAQ: MLNX). On Wednesday afternoon the company announced earnings, but not just any earnings, record earnings! The company announced revenue growth of 129.6% year-over-year, and a gain of 17.2% over its most recent quarter. The company also announced income of $48.40 million, compared to $4.80 million last year. Therefore, this wasn’t just a good quarter, it was a phenomenal quarter as the company grew in every single measurable category, and posted earnings growth that you rarely see in this economy.
As I said, you don’t see earnings growth of this caliber in this economy. However, let’s put this fact aside, and go back to the question. For a company growing at this rate how would you respond to such an earnings report? The company blew away Q3 expectations, but guided slightly below expectations for the fourth quarter, just $3-$10 million short, due to weakened demand for high-end server CPUs. Would you invest in such a company? Would you have bought the stock following such an incredible earnings report? Or would you have sold the stock because it “could” miss analysts’ sales expectations by $3-$10 million?
In case you didn’t notice, shares of Mellanox fell by a foolish 20% on Thursday following its earnings and guidance for the fourth quarter. The company’s third quarter was flawless, as all of its loss was due to its lower than expected guidance. Therefore, let’s put this into perspective one final time before moving on to determine why this might have occurred: A $3-$10 million “expected miss” resulted in a $20 loss or $831.60 million from the company’s market cap. Now I’m no mathematician or a genius by any means, but these numbers do not add up as far as I’m concerned, and I’m not convinced that anyone could logically explain such performance.
Those who sold, and the bears who follow the stock, will say that Mellanox’s loss on Thursday was a result of its one-year return of more than 200% (prior to Thursday) and an excessive valuation. However, this doesn’t make sense no more than the performance that occurred on Thursday. First off, in this economic environment companies that return 100% sales growth are given lofty valuations as a premium for performance. A good example is Linkedin (NYSE: LNKD), it trades with a price/sales of 16.00 and a forward P/E ratio of 87.80 because it’s growing revenue by 90% year-over-year. Just last week Workday (NYSE: WDAY) became one of the best performing IPOs of the year, and now trades with a market cap of $8.56 billion. However, this is a company that is not profitable, and made Linkedin’s price/sales ratio look undervalued. Workday is trading with a price/sales ratio over 40.00! Keep in mind, this is not P/E ratio, rather price/sales, which is just like a P/E ratio but uses revenue rather than earnings. Workday’s only catalyst, and the only way that investors can justify such a “dot-com” valuation is revenue growth of 100% in a tough economic environment.
As you can see, companies with 100% sales growth are awarded gaudy valuations as an award for strong performance. In the past I used Linkedin as the poster child for overvalued stocks, but it comes nowhere close to the ridiculous valuation in shares of Workday. But, here’s the catch, Mellanox is growing significantly faster than either of these two companies and trades with a MUCH more attractive valuation. It’s growing sales and earnings faster than just about any company in the market, and is showing no real signs of decline. Even its lower guidance for Q4 will still result in sales growth of 100% year-over-year, therefore Mellanox should have the same valuation that is seen in shares of Linkedin or Workday. In fact, it should see a greater valuation.
However, Mellanox trades with a price/sales of just 11.24, significantly less than either Linkedin or Workday, and a forward P/E ratio of just 18.57! Therefore, Mellanox is a value investment, to a large degree, and investors dropped the ball by following the leader and selling shares of this incredibly fast-growing company. So allow me to ask again, with all things considered, how much is a $3-$10 million miss in guidance worth? And considering that it has crushed all expectations for the last 16 months do you really think that Mellanox will miss this target?
BrianNichols owns shares of Mellanox. The Motley Fool owns shares of LinkedIn. Motley Fool newsletter services recommend LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.