Left and Right Handed Investing
J.A. is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There are two types of investors—those who love a great bargain and those who love a great story. Ok, that’s probably a simplification and there are a few more breeds, but value and growth stories seem to be one of the more polarizing dichotomies in the investment world.
Nothing makes a value investor happier than a stock smacked down by the market, selling at bargain basement prices and low PEs. Paying premium valuations for a company with no cash flow and declining margins would give the true value investor a terminal case of investment dissonance.
Give the growth investor a story stock moving massive amounts of product with rapidly rising revenue and he is in stock-picker’s heaven. High PEs, non-existent earnings, low margins -- no worries. Growth will solve bad numbers. The buzz and the hype surrounding a momentum growth stock is hissing, clanging noise to the value acolyte, but a familiar sweet refrain to the growth guy.
Netflix streams its way to the top
Netflix (NASDAQ: NFLX) started life attacking the very foundation of the DVD rental business—no late fees and no time limits for holding on to discs. It went on to kill Blockbuster and expanding subscription numbers gave growth investors a story to buy into.
In a decade, Netflix saw membership increase from 1.4 million to over 35 million by the end of 2012 and its price per share hit $300 in 2011. One great force that can derail the momentum stock bullet train is lower product sales leading to the perception that high growth is over.
When Reed Hastings, CEO, tried to separate DVD and streaming services and charge double in 2011, the backlash was swift and extreme. Subscribers protested and cancelled and investors left the building. Four short months later, Netflix was a $60 stock. In the back half of 2011, subscribers were cancelling and new additions slowed resulting in 32% decrease in unique subscriber additions.
They’re back —- the share price has literally raced up to over $260 in a couple of quarters with a PE around 648. Meanwhile the streaming model has sucked the life out of cash flow and margins, making value investors queasy. However, the resumed torrid pace of subscriber additions makes the numbers superfluous.
While declining operating and net growth along with disappearing margins cause the value camp to cringe, it’s the growth in the subscriber base and tepid recovery of earnings per share that brought buyers back. The 2012 EPS at $0.29 is not even in the same universe as the $4.16 earned in 2011, but it’s enough to make the faithful believe Netflix is on its way to world domination, unlimited subscriber growth, and extraordinary profits.
Domo arigato Mr. Roboto
Roughly translated, (apologies to Styx), it means thanks a lot Mr. Robot, and that is what investors have been doing if they own Intuitive Surgical (NASDAQ: ISRG) shares.
Intuitive sells robotic surgery equipment – the da Vinci-- and the tools and accessories that go with the systems. Sales are about evenly split but it’s the da Vinci that captures investors’ imaginations.
The PE touched a high of 60 three years ago, but even in decline does not quite qualify as value. As the PE went down and earnings rose, share price went to an all-time high of $585.
With an intact growth story quarter after quarter and year after year, Intuitive looked bullet-proof and there were expectations the da Vinci would never see weak sales.
Sales of da Vinci arms went from 335 per year in 2008 to 620 in 2012. Revenue since 2006 has increased at least 20% each year to about $2.18 billion by 2012 while the ISRG stock price is up five-fold. The da Vinci system robots are in 1,300 U.S. hospitals and were used in 367,000 U.S. procedures in 2012.
What happened in Q2 2013?
Net income dropped to $159.1 million ($3.90 per share) from 2012 a second quarter net of $188.9 million ($4.56). Analysts forecasted revenue to come in at $600 million yet Intuitive Surgical reported a disappointing $578.5 million. Even worse, the company cut guidance for 2013 and announced the range would be 0% to 7%, down from its previous guidance of 16% to 19%.
The second cliff down to $392 came on the heels of an FDA 483 letter in the third week of July. This is a letter outlining a possible violation of federal regulations -– Intuitive Surgical advised customers of a defect and instituted a correction without notifying the FDA. The company hinted that new da Vinci sales may have hit a ceiling as hospitals react to the FDA warning and existing customers don’t have the capacity to add more. While management tried to reassure investors it was a matter of timing, the market continued the sell-off.
Tesla speeds ahead
One of the most popular growth stories today is Tesla Motors (NASDAQ: TSLA). With just one quarter of positive earnings – $0.10 in Q1 2013 - after three years of losses, Tesla has seen it share price race from a 52-week low of $25 to a high of $133. Tesla has a negative PE.
Interestingly Tesla’s policy is to not report comprehensive vehicle sales numbers claiming investors are able to forecast success based on general sales figures. That leaves a lot of latitude on how many actual units of the Model X and Model S it sold and will keep investors glued to the numbers. This stock is a growth/momentum investor’s dream come true.
Revenue in the fourth quarter last year, was up 500% to $306 million and it delivered around 2,400 Model S cars in the quarter and 2,650 for the year. It’s clear the fourth quarter was validation of Tesla’s potential. The first quarter of this year was a continuation of the positive roll, with Tesla making its first profit ever, and the stock price hitting all time highs.
Industry analysts estimate first quarter sales were 4,750 Model S units and it looks like the company is on track to sell 4,500 units per quarter. As with all growth stories, bad news hits hard and Tesla dropped almost 18% when it looked like second quarter sales were slowing and came in at 4,181 units. Therefore, Tesla is still a value investor's worst nightmare.
Can an investor be ambidextrous?
It’s nearly impossible for the value investor to take a flyer on companies like Netflix, Intuitive Surgical, and Tesla even with pullbacks in price on bad news. All momentum stocks eventually get whacked a time or two on missed numbers or legal and accounting questions.
Value theory rests on margins of safety, high cash flow, improving margins, operating efficiency, and low relative valuations. Squishy stories and unlimited growth potential are concepts that are hard to quantify, and betting on ever-higher sales of subscriptions, robots, cars, burritos or everything under the sun is not wired into value investing DNA. It’s hard to be equally adept at both styles, and that's a shame.
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jgraham has no position in any stocks mentioned. The Motley Fool recommends Intuitive Surgical, Netflix, and Tesla Motors . The Motley Fool owns shares of Intuitive Surgical, Netflix, and Tesla Motors . 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!