Oct 27

As originally published on TheStreet.com
by Andrea Tse
10/25/2010

NEW YORK (TheStreet) — A number of widely-discussed stocks are poised to plummet — some by more than 20% and others by more than 50%, according to a number of investment managers we polled. From stocks that have serious fundamental issues to those that could drop on valuation, read on for three stocks that some market watchers think could tank within a year …

Barnes & Noble
Predicted Percentage Drop: Roughly 25%
Time Period: Next three to six months
Number of Analysts: 6
Average Recommendation: Hold
Market Cap: $899.2 million
Trailing Twelve-Month Operating Margin: 2.7%
Trailing Twelve-Month Revenue: $6.05 billion
Why Barnes & Noble Stock Could Plummet: “There’s a couple of different things,” said Brian Shepardson, co-portfolio manager of the James Market Neutral Fund. “On the big-picture issue, I think they’re facing a lot of competition from Amazon.com(AMZN_) and Wal-Mart(WMT_) … heavily in that area, too, so those are the two big places where we can purchase books, per say — like a hardcopy or paperback version. They’re also coming up against the iPads, the Kindles of the world that are bringing out content in a different format. So that’s kind of the rationale behind it. I don’t know if it’ll be to this extent, but it kind of reminds of — for a while Blockbuster — if you wanted to rent a movie, that was the big place that you would go to. And then came along Netflix( NFLX ) and delivering movies over the Internet — a different format without having to visit that physical store.

“Just looking at what we saw recently, I would say in the short-term, I could see it dropping back to $12, just where it was in July — maybe down to $10.77; that was its low back in 2008. I don’t see why it can’t touch there just in the immediate future (three to six months), then trickle lower than that.”

“Right now their earnings — they’re having a difficult time with their earnings. They’re in a negative position, so they actually have a negative P/E ratio; their return on assets is only around 1%. They’re paying a dividend, but their payout ratio is a 150%; so either they’re going to have to find a way to raise their income or else cut back on that dividend. It’s not just the story behind it; there are also some fundamentals within the company that we’re looking at.”

Salesforce.com
Predicted Percentage Drop: Up to 50%
Time Period: Next 12 months
Number of Analysts: 40
Average Recommendation: Outperform
Stock Price/Earnings Ratio vs. Industry’s: 901.91%
Market Cap: $14.7 billio
Trailing Twelve-Month Operating Margin: 8.1%
Trailing Twelve-Month Revenue: $1.46 billion
Why Salesforce.com Stock Could Plummet:”From a valuation perspective, all the cloud computing stocks are vulnerable,” said Harry Rady, chief investment officer and portfolio manager of Rady Asset Management. “I mean a number of these stocks are a trading at a hundred times earnings, so take your pick — Salesforce.com, VMware(VMW_), the whole space is just crazy.

“I look at them more as a basket. They’re both great companies doing really well, yet Salesforce is trading a 180 times trailing earnings and 90 times forward earnings and VMWare is trading at 105 times trailing earnings and 51 times forward earnings. So I don’t really have anything bad to say about them other than the valuations are ridiculous…”

VMware
Predicted Percentage Drop: Up to 50%
Time Period: Next 12 months
Number of Analysts: 34
Average Recommendation: Hold
Stock Price/Earnings Ratio vs. Industry’s: 413.53%
Market Cap: $32.2 billion
Trailing Twelve-Month Operating Margin: 12.4%
Trailing Twelve-Month Revenue: $2.41 billion
Why VMware Stock Could Plummet: “Fundamentally they are doing very well,” Rady continued. “But what you’ve got to remember is that product cycles are very short in this business and companies can be leapfrogged technologically almost overnight, so they’re only as good as their next product and if they stumble the stock could get cut in half. So expectations are that they just keep executing and keep putting out perfect product after perfect product; and that may happen — but we think it’s already discounted in the price of the stock.”

“VMWare is a great company with 20% long-term growth rates. So really well-run companies with growth rates like that should maybe trade at 20, 25 times earnings. So in our opinion, the stock should be down 50% from here.”

“Salesforce — same idea. It’s growing at about 25%, so perhaps the company should trade at 25, maybe even 30 times earnings, which gets you to a stock down more than 50%.”

Oct 19

Let’s face it, the last few years have been very difficult for investors and portfolio managers alike. One thing that should have become abundantly clear is the inherent conflict of interest between both parties. When times are good and markets are moving up at a steady pace, investors tend to become complacent and ignore potential pitfalls. However, when the markets turn down and the environment gets tough, investors panic and start to ask the questions they should have asked long before making their initial decisions.

I have the unique benefit of being a portfolio manager while also serving as chairman of the Investment Committee for Rady Children’s Hospital in San Diego. At Rady’s, I help identify investment managers that will complement the hospitals endowment portfolio. Throughout the year managers present to our team and inevitably the first question we ask is, “Do you and your team have a significant investment in the strategy you are managing?”  If the answer is, “No” the manager is likely to be eliminated from consideration.

I practice what I preach, because the portfolios I manage were established with my capital and I continue to add to them over time as I believe any managers who are worth their salt should have a substantial capital commitment to their strategies. This alignment of interest is often overlooked and should become one of the first questions all high-net-worth  investors should ask any current or potential money manager.

Having the managers’ capital invested pari-passu with yours may lower the likelihood of the manager taking inappropriate risks when they feel the “pinch” along with their investors when performance is poor.

The other component that is often overlooked is the net after-tax returns of a portfolio. After all, that’s what investors are left holding after paying Uncle Sam, the investment manager and any other associated fees. I’m always thinking about, and focused on, the potential tax consequences of any investment at year-end. I take portfolio risk management very seriously and believe that a good risk manager takes tax implications into account since it can be a significant permanent impairment of invested capital.  These are just a few of the factors that investors—and the advisors guiding their clients—need to pay closer attention to. After all, it’s the client’s money, not the money manager’s.