CWS Market Review – May 25, 2012

Boy has May been a frustrating month for stocks! The S&P 500 nearly went for an entire month without two up days in a row. We finally ended that run this week but the mess in Greece seems to be getting worse, and Facebook ($FB) had one of the worst initial public offerings in years. This IPO was a disaster for individual investors.

Fortunately, the stock market regained some of its footing this week. The S&P 500 managed to rise four days in a row and closed at 1,320.68 on Thursday. The index is still down nearly 7% from the four-year high it reached in early April. What’s not getting a lot of attention is that analysts have been increasing their earnings estimates for next year. The S&P 500 is currently going for about 11 times next year’s earnings estimate. That’s a good bargain, but I prefer to be skeptical about earnings estimates that far into the future. Still, it’s an interesting trend to note.

In this week’s CWS Market Review, I’ll talk about some of the issues surrounding Facebook’s IPO and I’ll tell you why I think the stock is a terrible, rotten, awful deal for investors. This IPO almost perfectly captures everything that’s wrong with Wall Street today.

As messy as things seems to be, the good news for us is that well-run companies are still doing well. On our Buy List, for example, we had a very nice earnings report this week from Medtronic ($MDT). In a few weeks, I expect to see the company raise its dividend for the 35th year in a row. Other standouts from our Buy List include Bed Bath & Beyond ($BBBY) which is close to a new all-time high. Also, Reynolds American ($RAI) has snapped back very impressively. But first, let’s take a closer look at the stock that’s on everyone’s mind: Facebook.

Don’t Invest in Facebook

Last Friday, Facebook ($FB) started trading as public company. This was the dream of all the investors who put money into the social networking company that was started in a Harvard dorm room eight years ago. Even before the shares started trading, there were problems. This was the second-largest IPO in U.S. history and the market was flooded with orders. The heavy demand caused trading in FB to be delayed for 30 minutes.

Almost every aspect of this offering was a mess. And what’s especially frustrating is that at every turn, individual investors were punished. Facebook simply got greedy and asked for too much money. However, I can’t put too much blame on a company for trying to get money for cheap. However, I can blame the bankers for not serving the best interest of their clients. The entire syndicate misjudged the interest in Facebook.

We also learned that the underwriters cut their estimates on Facebook in the middle of the roadshow. That’s outrageous! And we still don’t even know why but it apparently led to some major investors jumping ship. It turns out that some institutional investors were told of the downgrade while others were not. Meanwhile, many inexperienced retail investors bought Facebook using market orders. Ugh, that’s a big mistake. These were most likely the orders that were filled as Facebook ran up to $45 shortly after it started trading. Trust me: Never, never, never buy an IPO using a market order. You will get a terrible fill.

The fun in Facebook didn’t last long, and the stock dipped below $31 on Tuesday. Here’s a stat for you: Every penny in FB is worth $5 million for Mark Zuckerberg. Measuring from the stock’s high point, Zuck lost $7 billion. Between you and me, I think he’ll be okay.

Now let’s look at some numbers and we can clearly see that Facebook is wildly over-valued. The Street currently thinks FB can earn 65 cents per share next year. That’s almost certainly too low. To be safe, let’s say that Facebook can earn $1 per share in 2013. The estimated five-year earnings growth rate for Facebook is 35.9%.

If we take my patented “World’s Simplest Stock Valuation Measure,” (PE Ratio = Growth Rate/2 + 8 ) we get a fair value for Facebook of $25.95. This isn’t a precise measure for every stock, but it’s a quick and easy way to get a reasonable estimate. Still, this means that Facebook is over-valued by over 20$. The shares aren’t even close to being a good buy.

I can’t say that Facebook will suddenly plunge to $26, but the true value will eventually win out. My advice is to stay away from Facebook.

Look Forward to Medtronic’s 35th Straight Dividend Increase

On Tuesday, Medtronic ($MDT) reported fiscal Q4 earnings of 99 cents per share. That was one penny more than Wall Street was expecting and a 10% increase over last year. In February, Medtronic told us to expect Q4 earnings to range between 97 cents and $1 per share.

I was impressed by Medtronic this past year. Two years ago, the company had to lower its full-year forecast a few times. Even though the overall downgrade wasn’t that much, the Street was highly displeased. But last year, Medtronic gave us a full-year forecast of $3.43 to $3.50 per share and they stuck with it all year. In the end, the company earned $3.46 for the year which was right in the range.

The good news for Medtronic is that demand is returning for their pacemakers and defibrillators. For Q4, Medtronic’s revenues rose by 4% to $4.3 billion. For 2013, Medtronic sees earnings ranging between $3.62 and $3.70 per share. The Street was expecting $3.66 per share. Officially, that will be reported as “inline guidance” but I’m very pleased with it.

Sometime next month, I expect Medtronic will raise its quarterly dividend. The current payout is 24.25 cents per share which works out to a yearly dividend of 97 cents per share (or 2.62%). If I had to guess, I think it will be a modest increase—to 25 or 26 cents per share. This will mark their 35th-straight dividend increase. Medtronic is a solid buy anytime the stock is below $40 per share.

Looking at some of our other Buy List stocks, Ford ($F) had some very good news when Moody’s raised their debt to investment grade. This will help lower their borrowing costs. Few things can cut into a company’s profit margin like escalating borrowing costs. Three years ago, Ford needed to sell 3.4 million units in North America to break even. Today that figure is down to 1.8 million. I think Ford should be a $20 stock.

In last week’s CWS Market Review, I highlighted some of our higher-yielding stocks. I’m happy to see that Reynolds American ($RAI) responded by reaching its highest closing price in two months. RAI currently yields 5.63%.

The media paid a lot of attention to a patent trial that Oracle ($ORCL) brought against Google ($GOOG). I never thought this was a big deal. Oracle claimed that Google infringed on some of their patents with the Android software. The jury said no. One expert said the trial was “something like a near disaster for Oracle.” Financially, this is minor. Oracle continues to be a very strong buy here.

That’s all for now. The stock exchange will be closed on Monday for Memorial Day. I hope everyone has an enjoyable three-day weekend. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by on May 25th, 2012 at 7:02 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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