Happy Thanksgiving... Shorting valuations is dangerous, but sometimes profitable... Salesforce turns over... The crisis hits Germany...
Editor's note: We will not be publishing the S&A Digest tomorrow in observance of Thanksgiving. We hope you all have a wonderful holiday. We'll return on Friday with an exclusive interview with S&A Short Report editor Jeff Clark.
If you've read the Digest over the past few months (including yesterday's issue), you've likely heard us mention Jeff's extraordinary track record trading gold stocks. On Friday, Jeff will explain his strategy for finding winning gold trades… and other opportunities he sees today. When you wake from your turkey-induced slumber, check your inbox...
Shorting valuation is a dangerous game. While the company in your crosshairs may carry an absurd valuation, things can always get more absurd... As John Maynard Keynes said, "Markets can stay irrational longer than you and I can remain solvent."
The problem with shorting valuation – in other words, shorting a stock strictly because it seems expensive – is there's no catalyst... nothing to make those soaring shares turn over. That's why, in lieu of shorting based on valuation, we like to short three other scenarios:
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1. Fraud |
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2. Obsolescence |
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3. Companies drowning in debt |
All three of the above situations provide a catalyst... an accounting fraud – or fraud of some other type – coming to light, a disruptive competitor killing margins, or a missed debt payment.
Still... sometimes, shorting valuation works out. When a company is priced for perfection, even the slightest hiccup (including not growing fast enough) can send shares tumbling... Take, for example, Starbucks. In June 1999, Starbucks founder Howard Schultz announced plans to create Starbucks X, a semi-separate division built around the Internet.
Wall Street didn't like the Internet idea. One month later, Starbucks missed its earnings estimate. Shares dropped 20% in one day.
More recently, online restaurant reservation company OpenTable dropped 14% on November 2. The company earned $4.1 million, $0.17 per share, up from last year's $3.8 million, $0.16 per share. Despite revenue soaring 40% to $34.4 million, the Street wanted more – $35.7, million to be exact. OpenTable shares have fallen from a high of $118 earlier this year to below $34 today.
But as overvalued as OpenTable was, no growth-stock darling was as egregiously valued as Extreme Value short sale Salesforce (CRM). In his February 2011 issue of Extreme Value, Dan wrote…
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Salesforce is so overvalued, no reasonable set of expectations could justify its current share price. At around 250 times earnings, Salesforce is priced to grow at exorbitant rates forever with zero risk of competition. Once upon a time, Salesforce was growing rapidly. The year it went public, 2004, sales grew 88%. Had it kept that up until the present, it would now be making $4.5 billion in sales. (Instead, it's making $1.55 billion a year.) It would almost justify its market cap of $18 billion, and would trade around 62 times earnings... But 2005 was the last year Salesforce's revenue growth topped 80%. Though investor belief in it continues unabated, Salesforce's hypergrowth phase is thing of the past. It's gone and it's never coming back. In fact, Salesforce's revenue growth has fallen every year since the stock went public in June 2004. So the No. 1 reason to pay 250 times earnings for this stock is long gone. |
In addition to slowing growth, Microsoft announced it was releasing software to compete with Salesforce... And it would offer that software to existing Salesforce customers for nearly half what they were currently paying. Oh, and Salesforce insiders were dumping huge amounts of stock.
Shares of Salesforce have been in a steady downtrend since July of this year, at $160 a share. But they've fallen off a cliff this month. Since November 8, Salesforce has fallen from $134.13 to around $104 today – a 22% drop.
The company beat earnings expectations. But Wall Street didn't like lower billings and high hiring costs. Billings – a key metric for software-as-a-service companies – rose 29%, but failed to meet analysts' expectations of 33%.
And since last year, the company has expanded its workforce by 46%, nearly 7,000 employees. Bears say the company is hiring salespeople to make up for declining revenue.
Shorting valuation isn't easy… but kudos to Dan for nailing this one.
On the subject of Mr. Ferris... There was some confusion in the mailbag about whose 50th birthday it was. It was Dan's. Happy birthday, Dan.
Leading into Thanksgiving, we'd like to share some bearish news out of Europe (a surprise, we know). To date, the focus of this crisis has been the weaker European nations like Greece, Spain, Italy, and Portugal. Today, we have evidence the crisis is seeping into Europe's cornerstone, Germany.
The German government sold just 3.644 billion of its 6 billion euro 10-year bond auction at an average yield of 1.98%. To summarize, Germany couldn't find buyers for 40% of its bond auction. The failed auction sent European markets tumbling, and sent German yields (at 2.06%) above U.S. Treasurys for the first time since October. It was one of the worst German auctions since the euro began.
The euro fell to $1.33 today. Gold was lower, falling below $1,700, in all major currencies except the euro.
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New 52-week highs (as of 11/21/11): shorts of First Solar (FSLR), Salesforce (CRM).
If you're not an iTunes user, you can still listen to the Stansberry Radio podcast. Find out how in today's mailbag. Did you already listen to the Jim Rogers interview? What did you think? Let us know here... feedback@stansberryresearch.com.
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Goldsmith comment: You can listen to the Stansberry podcast here.
Good investing,
Sean Goldsmith
New York, New York
November 23, 2011