Pegasus Flies Too High

Pegasus Wireless (Nasdaq: PGWC  ) reported its second-quarter earnings with a press release titled "Company Demonstrates Extraordinary Growth With Record-High Revenue." In the release, CEO Jay Knabb describes the results as "thrilling" and says his company achieved "many important milestones." But despite Knabb's enthusiasm and his tendency to purchase company stock, I'm not convinced.

None of the events of this past quarter, now matter how remarkable Pegasus says they are, have changed my original opinion of this company. The problem is that the market capitalization is based on speculation and momentum trading rather than on the fundamental value of the business.

Quite simply, the company did not earn enough this quarter to justify its current market capitalization of more than $500 million. Revenue increased 10% to $25.4 million, and net income rose 8% to $247,863. That works out to about a penny per share in earnings, which isn't much of a payout for a stock trading at around $7 per share.

Pegasus bulls will say the earnings don't matter because the company has such a bright future. They will cite newly announced products such as wirelesscables, a gadget that makes a home-entertainment system wireless, and WiJet.e, a wireless-multimedia device. But do the bulls have any reason to believe these products will sell? Common sense says it will take more than a few nifty features to sell wireless-networking equipment, especially with the company competing against such established players as Netgear (Nasdaq: NTGR  ) and Cisco (Nasdaq: CSCO  ) . I would like to see the company earn a few million dollars in a quarter before I believe the story that management is telling.

Bulls also often cite insider purchases as a reason to load up on Pegasus stock. Knabb has been a frequent and consistent purchaser of company stock, and the second quarter was no exception. According to Yahoo! Finance, he purchased stock on the open market five times at prices ranging from $8.81 to $17.25. June 28 was a particularly noteworthy day -- he purchased 1.25 million shares at $8 per share and exercised stock options for 1.2 million shares at $0.325 per share.

I cannot fathom Knabb's motivation for sinking so much money into his own stock, especially at the current prices. Perhaps his day-to-day work at Pegasus has reduced his objectivity and he is simply being overly optimistic. Whatever his reasons for buying, it is wrong to assume that he's purchasing shares based on unreleased information. After all, it would be patently illegal for him to do that.

Regardless, I wouldn't advise blindly following his purchases. Instead, I'd focus on the company's performance. Pegasus has earned about half a million this year, which is peanuts for a company with a market capitalization of more than $500 million. Unless management can significantly grow earnings (i.e., by 10 times or more), I believe reality will eventually set in and this stock price will fall below $1 per share.

For related Foolishness, see "Pegasus' Broken Wings."

Tom Gardner'sMotley Fool Hidden Gemshelps you separate the wheat from the chaff among the market's small caps. Try it out free for 30 days.

Fool contributor Brendan Mathews welcomes your feedback. He does not have a position in any of the companies mentioned in this article. The Motley Fool has a strict disclosure policy.

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