My Trading > My Trading Journal > August 28, 2012

My Trading Journal

August 28, 2012

6:03 pm (PST)

NEW TRADES

I added 4,300 (SPLS) Staples shares at 10.73. I have 22,800 shares at an average of about 10.91. I'm only looking for a 30 cent pop so I can make about $7,000 in 1 week.

FACEBOOK

While on Morningstar today, I decided to check to see if they had published a valuation of Facebook stock. Indeed, they had. I was somewhat surprised at this because Morningstar is not the kind of company that concentrates on trendy stocks. Granted, Facebook does multi-billions in revenue and is a genuine company, but they only went public recently and Morningstar likes to have comprehensive financial data in order to do their financial modeling. Companies that have recently completed IPOs tend to have not have very long historical financial data available to the public.

Furthermore, I was even more surprised that Morningstar had given Facebook stock a very high valuation. You can see below a quote from their report:

"We value Facebook at $32 per share...Our valuation represents a multiple of 59 and 71 times our 2012 earnings per share and free cash flow estimates, respectively."
Not only are these multiples of 59-71 very high (since Facebook's growth is clearly in the 25-30% range), but these multiples are also very high considering that Morningstar has always been very conservative when assigning valuation multiples to growth companies. They have done a very good job in the past in avoiding the mistake of assigning high valuation multiples to companies that are growing very quickly but are about to "hit the wall" on growth. Over the past 2 years or so, I saw Morningstar assign Netflix (NFLX) stock a value of $150 when the stock was trading at $276. They did a similar analysis on OpenTable (OPEN) where they assigned the stock a value of $40 when it was trading at $111. They are not afraid to assign a down-to-earth multiple in the face of huge growth and positive investor sentiment when they believe the market is over-valuing that growth.

Furthermore, in their report they made a comment where they gave their opinion about the direction of Facebook stock in the short-run:

"We still believe the company is likely to disappoint investors for the next several quarters. While we are not intending to call for short-term moves in the stock, we do believe that slowing growth and declining profitability may cause the stock to trade significantly below our fair value estimate."
Although I do not have a problem with analysts stating their opinion about a stock's direction in the short-run - or making a long-term recommendation that contradicts their short-run opinion - Morningstar, in my experience, has never gave their opininon about the short-term direction of a stock. As a matter of fact, their whole style of analysis is specifically designed to ignore these short-term issues. Most of their equity valuation is based on discount cash flow (DCF).

Morningstar's high valuation multiple on Facebook stock, combined with their comment on the short-term direction of the stock, makes their report very curious. Although the hype around Facebook stock has created a flurry of interest among traders, it has also created a flurry of interest among financial publishers. I get the feeling Morningstar may have succumbed to the pressure for content publishers to create content specifically to meet the demand of people wanting to read about Facebook stock. Although I consider Morningstar to have the highest integrity among all investment publishers (except for myself, maybe), this is one example where I think they may be biased.

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