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  • Geoff Gannon 2012-04-20 15:23
    cor7997: Hi Geoff, many compliments to your great posts and deep explanations.
    I have a doubt: does TECH should deserve a BUY only because, for the last 10 yea
    Gisueppe,

    It's a great question. I wish I had a great answer for you. But I don't. The reason why I don't own the stock despite the great numbers is that I don't understand the business well enough. I think part of the reason why something like Chipotle (CMG) or Under Armour (UA) or Starbucks (SBUX) gets the valuation it does is because people think they understand the business and they think they see a clear future for the business in a way they may not for TECH.

    I think the sentence that really separates a company like CMG for TECH is this on in TECH's 10-K:

    "The Company manufactures and sells products for the biotechnology research market and the clinical diagnostics market. In fiscal 2011, 2010 and 2009, net sales from the Company’s biotechnology segment were 93% of consolidated net sales in each year."

    When people see that I think they stop thinking of it as a specific company and start thinking of it as industry bet.

    If you cover up the name and industry of the stock it looks great. Those are amazing numbers. That is a very profitable business. Not many businesses have an operating margin in the 40% to 60% range. And not many businesses have an ROE around 20% while using almost - not just no debt - but almost no liabilities at all compared to assets.

    But should we invest based on numbers alone?

    Or do we need to know something about "recombinant DNA technology".

    The business sounds great when you read about it too. They have all the right adjectives in their discussion of how the business works.

    And they have this bit in there too:

    "The Company believes that it is one of the leading world-wide suppliers of cytokine related products in the research marketplace. The Company further believes that the expanding line of its products, their recognized quality, and the growing demand for protein related and chemically-based research reagents will allow the Company to remain competitive in the growing biotechnology research and diagnostic market."

    But how do I evaluate that? I guess you could try doing some Phil Fisher style scuttlebutt. But I don't feel like I would even know enough to talk to someone who knew enough about what this company does.

    It sounds like a very conservative company in terms of financing:

    "The Company owns the facilities that its headquarters and R&D Systems subsidiary occupy in Minneapolis, Minnesota. The Minneapolis facilities are utilized by both the Company’s hematology and biotechnology segments."

    And...

    "The Company owns approximately 649 acres of farmland, including buildings, in southeast Minnesota. A portion of the land and buildings are being leased to third parties as cropland and for a dairy operation. The remaining property is used by the Company to house goats and sheep for polyclonal antibody production for its biotechnology segment."

    Not something I usually find in a high-tech company. They don't usually own hundreds of acres of farmland.

    Nor do they usually decrease the share count over time like TECH has. I love to see that. And of course now you are getting a dividend too.

    It's true that the market doesn't put a Chipotle like multiple on the company. But it's not like the stock has sold very cheaply compared to its earnings.

    It looks to me like the average P/E over the last 10 years has been anywhere from 22 to 40 times earnings. That's not low at all. Price to sales is almost never below 8 times - which is an insanely high number. If you have any sort of competition that causes your margins to move at all you would have really big losses in a stock with a price-to-sales ratio of 8.

    Price to cash flow is also extremely high in almost all years. So, while I do agree the company looks amazing on the numbers, I can't say it hasn't usually been rewarded for its performance with a nice multiple. It's obviously treated as a very high quality company.

    On the other hand, it's true that the company as a whole is not really valued any higher today than it was about 5 years ago.

    It's at the low end of where it has traded relative to sales, earnings, cash flow, etc. historically. So maybe it's a little cheaper than usual.

    But I can't say I would pay anything like the price it now trades at for this stock. I would have to be so sure about a business to pay those kinds of multiples of sales, etc. that it would be really hard to ever buy into as technical a company as this when it traded at a price like that.

    You need a very wide moat. It's very possible - it seems probable even - that this company has a really wide moat. But I don't think I'd trust myself to see that moat.

    Finally, CMG is basically a momentum stock. The kind of sustained stock price increases and very high multiples you see at CMG are really a fluke. It is not just about the business. It is about the stock. It is about people crowding into something where both the business and the stock are doing phenomenally well and confirming your investment all the time with that performance and that feels very good and...

    You won't find a bigger fan of Chipotle than me. I eat there all the time. I ate there last night and the night before that on my way home from work.

    And I'm not just a fan of the product. I'm a fan of the business. I watch people going up there and ordering and the simplicity of it all. I especially like how picky the customers are. There are so few choices you wouldn't think there's much for people to complain about, substitute this, no more of that, that's way too much of that. But it's all you hear.

    Also, I'm impressed by the number of times I see younger people bring in older people. Like you'll see kids and parents. And realize this is the first time the parents have been there. I saw that a couple times. And it was very interesting to witness. It's not like they are getting a lot of people who just like Mexican food.

    Honestly, Mexican restaurants are very close to the bottom of my list. And yet I go to Chipotle all the time. And they are overpriced. Everything else around them is the same price basically. They are bit higher. I know I'm paying like $2 more to go there than anyplace else.

    But none of that explains the stock. Momentum explains the stock. A business that never disappoints explains the stock. I don't think you have a lot of value investors in there.

    And people are overlooking some things. I had family visiting last month. And we were walking around where my apartment trying to find someplace for lunch and so naturally I'm explaining what each place is - giving them their options and I keep finding myself saying: "It's Chipotle. But for Greek food." / "It's Chipotle. But for Asian food." Over and over again. That's not a great sign for a stock that is priced where you are paying for growth quite a few years out.

    So, I can't really argue Chipotle is priced right. I don't know. I was working on a competitive score thing the other day, testing whether I could statistically rank companies in each industry according to basic financial ratios like inventory turns, gross margins, etc. that had specifically to do with competitiveness and nothing else - so I could even rank companies with no EBITDA - anyway Chipotle is at the top of the restaurant industry. I think Buffalo Wild Wings is also up there. Not a lot of others are even close.

    So it's not like people are wrong about how good their prospects are. But you will get to a point where it doesn't matter. I saw one analyst expecting like 70% EPS growth this year and still the stock would be at close to 40 times earnings. When you get to those kinds of valuations where having some of the fastest growing earnings of anyone out there isn't enough to get you even remotely close to a normal P/E you might have a problem. You're really betting on like 3 straight extraordinary years just to get to the point where you feel secure you aren't going to lose money in the stock.

    It's not all that common for stocks to be valued that way. So, I really don't think TECH is unusual in not being priced at those kinds of super fast growth - super long runway in front of them - companies. It's really just a handful of companies that draw so much attention their prices go completely crazy like that.

    When I look at most stocks of very good companies - I can't tell they are overvalued. For a very good company, it's hard to say they are overvalued. Outside of like the dot com bubble, you don't really have a lot of times where world class companies are just clearly priced so wrong you know they'll fall 50%.

    Usually, it's really marginal companies that people bid up in the last stages of a market rally where you know those prices are too high. Even Ben Graham felt this way. He thought the greatest danger wasn't paying too much for a great company. It was paying too much for a mediocre company during good economic times.

    So, to me TECH doesn't look especially cheap. That seems like a normal valuation for a very, very high quality company. And then just for me personally it seems like too technical a business for me to understand. So I wouldn't buy the stock myself even at a lot lower prices just because I feel I don't understand that business well enough. And I doubt it's something I can ever learn with enough confidence to buy a stock based on it.

    Thanks for the question.

    Feel free to write me anytime about anything.
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