Even when hot, fast-growing stocks are no longer bargains, you can often still profit from the companies that do business with them. But as costs increase abroad, the success of such a strategy is steadily becoming more difficult.
All about the contract
Coinstar (Nasdaq: CSTR) certainly looks tantalizing, with 19,000 coin-counting machines and nearly 27,000 Redbox DVD rental kiosks. But while both businesses are attractive, the DVD rentals generate about 80% of Coinstar's income, and competition in that arena is fierce. True, Blockbuster recently filed for bankruptcy protection, but Netflix (Nasdaq: NFLX) remains strong, growing earnings at more than 20% annually. Its burgeoning streaming-video business offers even more convenience to customers than Redbox's kiosks.
If you're drawn to Coinstar and its expected near-term growth, but worried about its competition, you might look at Flextronics (Nasdaq: FLEX) -- the contract manufacturer that actually makes the Redbox kiosks. As those boxes proliferate, they'll bring more business to Flextronics, which sports a more down-to-earth valuation and a more diversified revenue stream. The company also supplies Cisco Systems (Nasdaq: CSCO) and Apple (Nasdaq: AAPL), and if you've ever taken your broken cell phone into a Verizon (NYSE: VZ) store, you may have been helped by a technician who was employed by Flextronics .
Unfortunately, part of the cost advantage that companies like Flextronics enjoy comes from the significant amount of Chinese labor they've used. In recent years, development in China has driven steady wage growth there; the cost of Chinese labor now reportedly approaches that of Mexico. These higher wages might pressure manufacturers' profits, which may drive them to raise prices for the larger companies that now rely upon them.
Contract manufacturers have served many investors well over time. But the growing wage threat should encourage you to cast a wider net when searching for promising investments. Plenty of compelling companies will be far less hurt -- or even helped -- by changes in China.
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