The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

20 April 2007

Growth stocks, but at value prices

Two of my 9 core investment opportunities were in the news yesterday...
1) Google/GOOG, which continued its strong performance with first quarter earnings announced after yesterday's close, topping both the Street's EPS and revenue estimates. Excluding one-time items, EPS came in at $3.68 (net of $1 billion), while revenue was $3.7 billion, or $2.53 billion after subtracting advertising commissions and other payments to its partners. Both numbers beat consensus analyst forecasts, which called for EPS of $3.30 on revenue of $2.49 billion. The company's billion dollars in net income was largely derived from search advertising revenue. According to researcher eMarketer, Google will account for an estimated 75% of all U.S. search ad revenue this year, versus just 16% for rival Yahoo. On the conference call, CEO Eric Schmidt said he was "ecstatic about our results." Google also announced that in addition to his duties as CEO, Schmidt would now also serve as Chairman of the Board.
Stifel notes GOOG reported net revenues of $2.55 bln and diluted EPS of $3.68. Firm notes gross margins declined slightly to 60.0%, down from 60.3% last quarter. Net margin was down sequentially from 46.2% to 39.3%. International revenues contributed 47% of total revenues, compared to 44% in the fourth quarter of 2006 and 42% in the first quarter of 2006. Firm notes they would be aggressive buyers of the stock at current levels...
Cantor notes GOOG posted strong 1Q07 results, reinforcing their view that the company is taking considerable share in the rapidly expanding online ad market and solidifying its status as the linchpin to the Internet economy. Firm notes GOOG delivered extraordinary y/y net rev growth in conjunction with impressive EBITDA margins, a unique combination for any company but particularly so for one of GOOG's size and in comparison to other Internet bellwethers.
ThinkEquity raises their tgt on GOOG to $620 from $600 following strong 1Q07 as the company continues to gain global share and drive out-sized advertising yield in its core search business. They believe GOOG has additional revenue drivers emerging in offline advertising, video, and mobile -- each of which could be $1 bln+ opportunities in several years. Firm notes GOOG also continues to demonstrate strong share gains and monetization trends in the faster-growing international markets and should increasingly expand the reach of its network business to become more relevant for branded advertisers...
Bear Stearns believes that while there are plenty of reasons to be pleased with GOOG's results, that the next leg of the stock will be driven by what's on the horizon for GOOG - the cash flows from outside the core business. Firm believes that the mere proving of progress in any of these areas would be enough for investors to give some credit, and hence drive the next leg of the stock closer to their $600 2007 tgt.


2) Intuitive Surgical/ISRG
Wachovia notes that ISRG reported a strong quarter despite a slight system shortfall. Firm notes that ISRG placed 44 systems in the quarter against consensus of 45-46 systems for systems growth of 32%. They note that Q1 2007 marks the first time that recurring instruments and service revenue made up the majority of ISRG's sales (50.9% of total sales). They view the increased contribution from recurring revenue as a significant positive since it should reduce revenue volatility...
Jefferies says that while they remain long term supporters of the company and its core technology, they are skeptical about a deceleration in unit placements. That said, all key metrics demonstrated solid improvement (including recurring revenues) and they remain optimistic in the da Vinci's prospects for 2007 and beyond. Firm maintains their Hold rating, and raises their tgt to $110 from $108.

So how is it that I name this post -- how does the investor purchase (stunning) growth but at value prices? One is the more common approach: true growth stocks (of which GOOG and ISRG are great examples) maintain their phenomenal growth for more than a season or two. Thus, their PEs shrivel, especially in comparison to their PEG (discussed previously); both Google/GOOG and Intuitive Surgical/ISRG now sell for a forward multiple of ~32 -- extraordinarily cheap for growth companies such as these. The second and less common method would be on the basis of the chart; prolonged periods of non-(general market) leadership cause the formation of a long term base. And such is precisely the case for these two leaders that will again lead to new and substantially higher highs.

For the record, ISRG is in the process of breaking out above its crucial resistance of $132, with explosive volume. GOOG continues in its base; its appears necessary to do more sideways base-building, albeit at the top end of its base. Congratulations to any reader who had the foresight to follow my recommendations to purchase these leaders. Even better times than today's outsized price moves lie dead ahead.

A side note. After a 2 year effort, it appears increasingly obvious, even to a dunderhead such as me, that there exists an insufficiency of interest in a website that is, in the words of one reader, "literate, intelligent, helpful, and money-making" for me to continue the effort. Although I have yet to make my final decision, I feel bound by honor to mention that this blog seems to be on its last legs. I appreciate all the many kindnesses you have shared publicly and privately, no less your continued readership.

Best wishes,

-- David M Gordon / The Deipnosophist

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