Streetwise

Lauren Rudd

Sunday, July 25, 2010

Gullibility is Rich Fare For Those Who Feast on the Uninformed

In an effort to counteract the vagaries of Wall Street, investors are often persuaded to chase phantom opportunities in a relentless but futile pursuit of unrealistic gains. The apparitions of wealth that continually mesmerize and beckon the unsuspecting remind one of the Sirens in Greek mythology whose seductive songs lured sailors to their death.

Meanwhile, gullibility is rich fare for those who feast on the carrion of the uninformed. To quote from Idiot America by Charles Pierce, “Fact is that which enough people believe. Truth is determined by how fervently they believe it.”

Last week I mentioned a parable, attributed to Kermit Long, about two men, one of whom mentioned he had just heard a cricket. The other commented he had heard nothing and asked his companion how was it possible to hear a cricket amid the din of the city?

The first man simply took a coin from his pocket and dropped it on the sidewalk, whereupon a dozen people began looking around. “We hear,” he said, “what we listen for.”

There is no fault in listening to the vast myriad of investment ideas. It is when you act without sufficient due diligence that the price tag escalates exponentially. To use a more colloquial adage, proceed imprudently and your investment will resemble one of Florida’s renowned alligators...and you a hot lunch.

Ignore the endless parade of parasitic investment letters, TV performers and commission sales people, all touting the same repetitive monologue; they have the keys to hidden wealth...and you do not...but you could. Believe me, if they really had the answers they would not be living off subscriptions, advertisers and commissions. Now I know what you are thinking, so where are my investment ideas of late? I am glad you asked because today is a double header day.

First up is Gilead Sciences (GILD). Here is a cricket that nobody seems to be able to hear. A year ago my 2009 earnings estimate was for $2.55 per share and the company produced earnings of $2.82 per share. Revenues were $7.01 billion, up 31 percent from 2008. More recently, net income for the second quarter of 2010 was $0.79 per share, as compared to $0.61 per share a year ago. Revenues for the quarter increased 17 percent to $1.93 billion. And yet the share price recently closed at $33 per share, down from $49 a year ago.

The intrinsic value of the shares using a discounted earnings approach is $76 and $101 per share utilizing the more conservative discounted free cash flow to the firm approach. My earnings estimate for 2010 is $3.64 with a 12-month projected share price of $40.

One of the things you learn early on in dealing with Wall Street, assuming you survive the experience, is not to step in front of a fast moving freight train. There are stocks that defy the imagination and Green Mountain Coffee Roasters (GMCR) is an excellent example. Unlike many touted story stocks of the past, Green Mountain does have solid revenues and earnings. However, of concern are factors such as a trailing 12-month P/E ratio of 58. If the company paid out all of its earnings to shareholders, it would take 58 years for you to recoup the share price. Could there be a bit of the Greater Fool theory here?

Nonetheless, net sales for the second quarter increased 68 percent to $324.9 million, while net income was $0.54 per share, as compared to $0.20 a year ago. The Company also distributed two additional shares of its common stock for every one share held to all shareholders of record on May 10. The shares began trading on a split-adjusted basis on May 18, meaning the May 17 closing price was divided by three.

The company’s earnings guidance for the year is $0.68 to $0.71 per share, split adjusted. The intrinsic value of the shares using the discounted earnings model is $52, while the free cash flow to the firm method yields an intrinsic value of $125. The shares recently closed at $29.34. My 2010 earnings estimate is $0.69 per share with a 12-month projected share price of $34.