Earn Long-Term Profits From Short-Term Selling In Micron Technology

“I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime. Even people who lose money in the market say, 'I just lost my money; now I have to do something to make it back.' No, you don’t. You should sit there until you find something.” – Billionaire Investor Jim Rogers in Market Wizards

Those of us who have the patience to keep some of our capital readily available at all times can follow the sage advice of Jim Rogers and “go over there and pick it up” when the short-sightedness of panicked investors leaves “money lying in the corner” for us. Today, a short-term and solvable problem at Micron Technology (MU, Financial), coupled with the skittish nature of investors, seems to have presented us with just such an opportunity.

From the perspective of value investors, one of the magnificent aspects of the stock market is the propensity of investors to run with the herd in and out of stocks on the slightest bit of news and move prices to absurd lows and highs. This takes place on a surprisingly regular basis and it doesn’t seem to matter how high quality a business is or how necessary its products are.

Those who follow my analysis work on a regular basis will be well aware of my affinity for businesses that provide products or services that are integral parts of our way of life and have applications in both business and consumer markets. I also like to see products or services that require some kind of on-going servicing or are typically replaced in five years or less.

According to IT Consulting NJ, Gartner Research conducted a study of 177 large businesses and discovered that the average life span of a desktop PC is 43 months and only 36 months for mobile PCs.

On September 16, 2014 the CE Product Life Cycle Study estimated the average life of a consumer Desktop PC to be 5.9 years and 5.5 years for a notebook or laptop computer. When combined with the average life of business-owned equipment, we end up with an average replacement cycle of just about 5 years. At the top end of my desired range but still attractive.

But the computers themselves are not much more than a commodity product and, as Warren Buffett (Trades, Portfolio) likes to say, are subject to the lowest price available in the world. And in the world of PCs, the name on the outside of the case has very little to do with how the product functions. However, the components inside those boxes do matter.

Micron Technology lives inside the box … where it counts

And inside the case where the components do matter is where Micron Technology’s products make their home. Micron Technology, Inc., together with its subsidiaries, provides semiconductor solutions worldwide. The company manufactures and markets dynamic random access memory (DRAM), NAND flash and NOR flash memory products, packaging solutions and semiconductor systems. The business is divided into four segments: Compute and Networking Business Unit, Mobile Business Unit, Storage Business Unit, and Embedded Business Unit. The company offers DRAM products for data storage and retrieval, including DDR4, DDR3, and DDR2 that offer high speed and high bandwidth; reduced latency DRAM products that offer lower power consumption relative to other DRAM products; and other DRAM products to specialty markets, such as DDR2 DRAM, DDR DRAM, GDDR5 DRAM, SDRAM, reduced latency DRAM, and pseudo-static DRAM products that are used in networking devices, servers, consumer electronics, communications equipment, computer peripherals and automotive and industrial applications, as well as computer memory upgrades.

It also provides NAND flash memory products, such as flash memory cards comprising CompactFlash, Memory Stick, and Secure Digital; and JumpDrive products that are used in mobile phones, solid-state drives, tablets, computers, industrial and automotive applications, and other personal and consumer applications. In addition, the company resells flash memory products that are purchased from other NAND flash suppliers. Further, it provides NOR flash memory products that are electrically re-writeable, non-volatile semiconductor memory devices used in consumer electronics, industrial, wired and wireless communications, computing and automotive applications. The company markets its products to original equipment manufacturers and retailers.

While much has been made about the death of the PC, it is presently quite difficult to see anything that is ready to replace it for business and heavy home use in the immediate future.

Capitulation by investors leaves money lying in the corner

One of the characteristics I look for when trying to identify a true buying opportunity in a stock is what is often referred to as capitulation. This is a condition where a stock falls precipitously on very heavy volume either on no news or in a vast overreaction to a particular piece of news. In the case of Micron Technology, our opportunity seems to have been created by the latter.

After the market closed on Thursday, June 25, Micron Technology reported earnings for the second quarter of fiscal 2015 which ended May 31. The analysts’ consensus expectations for the second quarter earnings had been $0.56/share, and the company reported $0.54/share.

Interestingly, the company had exceeded the consensus earnings estimates in each of the previous three quarters. So, what was the market reaction to Micron Technology missing the consensus estimate by approximately 4%? On Friday, the stock fell $4,36/share which represented a decline of 18.15%! This might cause some to speculate that the market overreacted.

However, selling in a stock that misses earnings expectations, even by a small amount is like watching a herd of cattle when a stampede is just getting underway. First there is nervousness among some members of the herd and others begin to notice the concern. Then, almost suddenly, a few or more panic and start to run, forcing their way through the unstartled cows in a desperate attempt to reach the uncongested area outside the herd. As these cows panic, their fear causes more concern and panic among the other cows who have no idea why these cows are afraid, they just assume there is a good reason. They, in turn, become scared and panic themselves. Then it spreads like wildfire and all of the cows will do anything to get away from the unknown cause of the fear.

The stock market functions much the same way. On an average day over the last 90 days, MU has traded 24,188,749 shares. On Friday, that number rocketed upward to 149,010,345 shares changing hands.

In one day, based on an earnings miss of less than 4% from what was expected, the stock fell over 18% on more than six times its normal daily volume. With a large smile, I said to myself: “The efficient market theory at its best; once again handing me my opportunity at its best!”

Now, it is very true that the PC market is currently experiencing weak demand, and there is no question that has put pressure on Micron’s sales and margins. However, we are still left with a business that earned $0.54/share in a very difficult quarter.

Past quarterly earnings indicate stability

In a market that is showing overall weakness, it is hard to look forward with certainty. However, what the past performance of Micron does tend to indicate is that there is not a great deal of seasonal fluctuation in the earnings. Therefore, we might derive some forward guidance by looking at the current consensus projections from the analysts who cover the stock on a full-time basis.

These projections can be found at Yahoo!Finance and are shown in the table below:

One of Wall Street’s favorite euphemisms is: Never try to catch a falling knife. Normally, I agree with that time-tested adage. However, there are exceptions to every rule and a stock can become so cheap that it warrants taking a bit of extra risk.

Based upon the current consensus estimates of $2.79/share for the year ending in August, Micron is trading at a very low price to earnings multiple (P/E) of 7.05 times 2015 earnings. Even if the current year projections were to decline another $0.67/share over the next 60 days, the stock would still be trading at a P/E of only 9.27 times earnings.

This stock is cheap.

If we grab the falling knife, do we have a safety net?

As a value investor, I am not afraid to buy businesses from which others have turned away. After all, businesses that are loved by the herd are never going to be priced at low valuations. To find their way onto my screen, they have to be hated. But for me to buy a business, being hated by others is not enough. I require protection for my investment capital.

In the balance sheet of Micron Technology, I believe I have found a very thick and thinly veiled, if veiled at all, moat of protection for my investment capital. Sometimes a review of the balance sheet reveals why a business is priced cheaply. Other times, it reveals that a business that appears to be inexpensive is just plain stupid cheap or, as Jim Rogers likes to say, is money lying in the corner.

As of May 31, Micron’s balance sheet showed the following:

Cash and short-term investments: $ 4,860,000,000

Receivables: $ 2,530,000,000

Inventory: $ 2,381,000,000

Total: $ 9,771,000,000 or $9.03/share

Since in a technology business, inventory can become stale rather quickly, we should also consider the value of this current asset at 50% of cost value … just in case. Using this very conservative valuation of the inventory, we are still left with $7.93/share of what could essentially be considered cash on the books … 40% of the market value of the business!

There is more to this particular metric that needs to be considered when it comes to the effect it has on the intrinsic value of the business. It needs to be considered in light of the current liabilities. In this case, they amount to $4,811,000,000 or $4.45/share.

After subtracting this figure from the current liquid assets, we are left with values of $4.58/share with fully valued inventory and $3.485/share if the inventory is valued at only 50% of book (cost). These figures represent 23.3% and 17.7% respectively of the current market value of the business. This provides a very hefty margin of safety on top of what is already a cheap valuation.

What is the future expectation?

The table below from Yahoo!Finance displays that the analysts covering Micron expect the company to expand its earnings at a pace of 15%/year over the next five years. As the table also shows, this assigns the business a price-to-earnings growth rate (current year P/E divided by five-year projected growth rate) of 0.47. Most analysts consider any figure of 1 or less to be cheap.

Even without any improvement in the PEG calculation, if the analysts are right and the company grows earnings at 15%/year, a similar rise in the share price would still leave us holding a very cheaply valued stock while collecting an exceptional rate of return.

Is there a catalyst that can push the stock higher?

Just because a stock is undervalued or downright cheap, that does not necessarily mean it is going to move higher at any given time. If there is no recognizable catalyst that should push the share price higher, any investment can quickly become not much more than dead money. If we want dead money, we can open a bank account! We are seeking investment opportunities with exceptional potential for upside gains.

According to a June 26 report from MarketWatch, Micron is pushing hard to convert a significant amount of its manufacturing capacity for DRAM memory to the type used by mobile devices and servers. This should provide a dramatic improvement in the positioning and flexibility of the business. This type of shift does not happen overnight and impatient investors have crushed the stock price through their refusal to wait. If it were not for stampedes by the impatient herds from time to time, it would be virtually impossible to find money lying in the corner.

The hasty action by a stampeding herd of impatient shareholders has now created our compelling opportunity to buy today and patiently collect stellar returns for years to come.

What is the stock worth today?

If we simply value the stock based on this year’s projected earnings of $2.79 and a price-to-earnings growth rate of 1 multiplied by the 15% annual growth projection, we would calculate a current fair value of $41.85/share while completely discounting the massive safety net of short term assets on the balance sheet. This would produce a 113% capital gain from the current price.

While this might sound like an improbably move for a stock of this size, the chart above clearly displays that this business is no stranger to explosive price moves in both directions. Over the first half of this year, this business has seen its value shredded by 46%. It is now cheap and hated and after almost 15% of the total shares were sold last Friday while the stock collapsed by more than 18%, how many sellers do you think are left? I am guessing not many.

If the calculation above is off by 25% and the stock is only worth $30/share, we are still looking at 50% upside plus the 15%/year forward growth. If the transition to production of more DRAM memory for mobile devices is successful, any of the forward projections shown here could become even more conservative very quickly.

Final thoughts and actionable conclusions

In cases like this, we have already received excellent advice on the appropriate action to take from one of the most successful investors of our day. There is money lying in the corner, and we should walk over and pick it up. The only logical alternative to this approach would seem to be if we chose to run over and pick it up instead. I suggest buying shares of Micron Technology up to $21.00/share and holding for three to five years. I would further suggest placing a stop loss order at $42 once it has passed that level and then selling half the position if it retreats below that level once it has crossed it. After that, I would implement the use of a 15% trailing stop on the remainder of the position and holding on for the ride.