A few weeks back, Fool co-founder David Gardner discussed the six signs of a Rule Breaking company . Over the past few weeks, our analysts have examined each of these signs in greater depth. Once the series has run its course, you should be able to identify Rule Breakers for yourself. Today, we'll look at sign No. 6: You must find documented proof that the company is overvalued according to the financial media.
There's money to be made when there's blood on the streets, so the old Wall Street adage claims. In other words, when a company falters, the market has a way of overreacting to the malaise and patient investors can make a mint by buying the fallen shares. Perhaps. However, I'd like to coin a new adage today: There is money to be made when there's venom on the streets.
Yes, venom. When analysts are lobbing "overvalued" bombs at promising growth stocks, you'd do well to act on the skepticism. One way or another, there's an opportunity there. Do a little research. Find out where you stand. Maybe you ultimately find yourself siding with the bearish market watchers and grabbing hold of the battering ram that they're yielding. However, don't be surprised if you find yourself on the inside, battening down the hatches and defending your financial conviction.
Playing hardball with the bad news bears
Pessimism sometimes wins. Sometimes some true duds are rightfully called out as pretenders. The key is knowing the difference between the doomed and the misunderstood.
The stock's price spurt and the company's knack for quarterly deficits had more than a few Wall Street analysts advising shareholders to bolt for the exits. Lehman Brothers analyst Holly Becker argued that the stock may have been overvalued by as much as 48%. Was Holly right? Well, three years later you're welcome to pull up a quote on the popular e-merchant. Amazon.com stock has tripled off those presumably nosebleed-inducing levels.
A more recent and obvious example is Google
It was once thought that the company's offering would fetch as much as $135 a share. When the IPO price was actually $85 a pop, critics thought they'd called it right. History proves otherwise. If you bought Google at $85, you've done well. Your investment has gone on to triple in less than a year.
Getting over overvalued
With a whopping 1.3 billion shares outstanding, Sirius Satellite Radio
That hasn't stopped shares of Sirius from tripling over the past year. Soaring revenue growth, top-shelf programming content, and the widespread excitement of satellite radio has the market buzzing over "SatRad" in general and Sirius in particular.
"Despite an aggressive forecast of 9.9 million subscribers by 2010 vs. around 400,000 today," read a Wachovia report issued last summer, "we believe that Sirius is overvalued at this early stage highlighted by an enterprise value of $4.4 billion as compared to 2003 revenue of $13 million and projected revenue of $65 million in 2004."
Yes, that was a bad call. And I certainly don't want to appear as some omniscient know-it-all. I've blown more than a few in my time. However, that assessment highlights where many flawed pundits go wrong. No one was buying Sirius based on what it had done a year earlier. Frankly, no one is buying Sirius based on its present state of revenue generation.
The terms "cheap" and "expensive" are always changing
If an analyst produces a bleak outlook on a company based on a trailing sales or earnings multiple, that should get your mouth watering. That's the kind of rearview mirror investing philosophy that should excite growth investors as an opportunity to go the other way. Investing is all about the future. Those stuck looking at the past are just asking to be blindsided with improving fundamentals.
When the Fool's growth investing newsletter, Motley Fool Rule Breakers, recommended Harris & Harris
What about the perfect setup that Apple Computer
Yes, at least you have to give those market watchers props for having the gumption to use forward profit estimates. The problem is that those numbers hadn't chewed on the incremental merit of the company's digital music popularity and how the "halo effect" would come around to grow the company's flagship computing business. For those keeping score at home, Apple shares have more than quadrupled since the Barron's article came out.
So why waste your time buying today's cheap stocks? From a long-term perspective, tomorrow's great growth stocks are cheap today. You know, the ones that seem so outlandishly expensive to analysts who, in fairness, are often required to provide a short-term outlook. Be contrary -- and start hunting for them.
For related Foolishness:
- I reveal sign No. 1 in Be First, Be Great.
- Charly Travers examines sign No. 2 in Thwarting the Big Bad Wolf.
- Tim Beyers checks out sign No. 3 in Invest in Bottle Rockets.
- John Reeves walks us through sign No. 4 in Spotting the Next Jeff Bezos.
- Alyce Lomax deconstructs sign No. 5 in Stocks With Star Power.
Longtime Fool contributor Rick Munarriz has never been called overvalued, but that's because he always removes the price tags from everything he wears. He does not own shares in any of the companies mentioned in this story. Amazon.com is a Motley Fool Stock Advisor recommendation. The Fool has adisclosure policy. Rick is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.