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Re: High P/E Ratio - Problem?

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By NorthCarolinaKen
February 8, 2005

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This is a very interesting company [Vasco Data Security (NASDAQ: VDSI)] from a technology market point of view, because it addresses authentication with small devices like PDAs, cell phones and so on. The technology is similar to what we call VPN, virtual, private networks. That is good news and bad news. The good news is that the technology segment is established but the bad news is that they don't have much of a "moat." Competition can come in hard and fast. On the good news side, the awareness of the vulnerability of small digital devices is rising. It is in the press and probably the cause of the one-year bump in revenue.

Given that, I am not interested in investing in this stock. What I am looking for in a new tech company is sharply rising revenue. An astronomical PE like this one can be OK in that situation as the rising revenue may not be covering the costs of the business yet. Often, high PEs for tech stocks in that kind of position scares investors away, but these are exactly the troubled waters I want to fish in. A bright future, sharply rising revenue on a short track record, and a depressed stock price. Never mortgage the ranch for a stock like this but careful investing small percentages of your portfolio can win big.

If I look at this stock, the revenue has been all over the map. From 1999 we have (annual), $19.4, 28.07, 26.73, 18.91. 22.87 (for 2003). The net losses likewise are all over the place. In 2004, there has been about a 24% jump in revenue, quarter over quarter and for the first time, we see positive numbers on the bottom line.

What I think we are seeing is a jump in demand for small unit authentication that has juiced the revenue and hit the bottom line.

If you look at the 52-week high/low prices you see $1.81 and $8.28 with the stock around the latter number. If you go backwards in time, you can find prices less than $1. So the question here is whether the great hope based on the great leap in 2004 revenues is priced in the stock, or not? "Hidden Gems" obviously is not too hidden. Where I find big winners, there is little or no following. Vasco also made the Dow Jones Analysts Highest Rated Stocks list. No secrets here. Wall Street is already there and that's why the stock is so high.

So, looking at this stock at $1.81 why didn't you buy it then? The story is the same. There has to eventually be a market for small unit authentication. You see the story, you believe in management, you are a long term investor. Buy and wait. If you had done that, you likely would be selling into this run up. 400% in a year is not too bad after all. Maybe time to take a little off the table. This is a selling situation, not a buy.

I would not have bought the stock at $1.81, not because of the story but because I want to see some evidence of a viable market with rising revenue. I wouldn't buy it now because the price is astronomical. Is this an Amazon.com? I don't think so.

This sudden jump in revenue after five years, is it a blip or the start of a big run up? If it is a blip, the stock will crash. If it is a big run up, one of two things will happen. On the happy side, a company like Cisco might buy them. On the unhappy side, a company like Cisco will take them on and squash them like a bug. This is gambling. Las Vegas is more fun and you can ogle the beautiful women and drink.

I say no way to this stock.

My recent purchases are LTON, POWI, PECS, LUV, SLAB. I share that not that you should run out and buy these things but to give you some opportunities to think about. All the gurus including Peter Lynch, Ben Graham, Warren Buffett, Kenneth Fischer and Ben Stein (see his great little book on market timing) emphasize buying value at a bargain price. That I believe in a nutshell is what this investment game is all about.

Ken


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