Deja vu, Akamai style

As I wrote in October, SmartGuyStocks selection Akamai (AKAM) seems to be falling into a pattern.

1. Akamai reports strong (40%+) YoY revenue and profit growth, in line with or ahead of expectations

2. Analysts predict the end of the company’s growth at the hands of growing competition

3. Akamai reports strong (40%+) YoY revenue and profit growth, in line with or ahead of expectations

Given that this has been going on for a few quarters now, I think we can guess what the investment community’s reaction will be tomorrow.

But I’m still holding out hope that some analysts will finally re-consider their doom and gloom mantra, as Akamai’s results for the fourth quarter certainly appeared to snuff out any competition fears. Not only did revenue increase 14% and profit 22% over last quarter(!), but gross margin even increased by 20 basis points. CEO Paul Sagan certainly had every right to brag that “the value of Akamai’s differentiated services is stronger than ever.”

Sagan also reassured investors in this uneasy market climate, insisting that an economic slowdown may even help Akamai. Since companies save money by moving operations to the Internet, Akamai would benefit if the migration process picked up as businesses seek to cut costs in a tougher economic climate, he said.

A large driver of Akamai’s growth is the downloading of video content. The company provides technology that allows companies and government agencies to deliver digital internet content, such as commercials and videos. Between the announcement by Apple of a movie download service, the internet-only NBC soap opera “Coastal Dreams”, and the proliferation of forwarded video clips in my inbox, the growth of video is one trend you can count on. And given Akamai’s track record and position at the forefront of content delivery technology, this is one company I’m willing to bet on.

Disclosure: SmartGuyStocks is long AKAM

Nasdaq on track

It’s been tough to jump into this market. Nearly every day, the pundits seem to change course on whether we’ve already hit bottom or are only at the tip of the recessionary iceberg. At SmartGuyStocks, we have decided to generally sit on the sidelines for now with our favorite long-term plays and wait for things to shake out a bit before taking any new positions.

So while we’re waiting to jump back in, I wanted to take this opportunity to catch up with one of our favorite companies, Nasdaq Stock Market (NDAQ). Despite a market slump, the stock is up nearly 30% from where we recommended it in July, and we believe it will continue to be a winner for years to come.

Last week, Nasdaq followed the huge swings of the market, temporarily nose-diving on fears of a recession. Ironically, Nasdaq is minting cash out of those fears in the form of transaction fees from record share volume. Last week, Nasdaq CEO Bob Greifield announced “At the moment, our business is doing better than it ever has because the volumes have been incredibly high,” he said. “So, it’s (the recent period of high volatility) been very good for us.”

And don’t be distracted by the hubub over the potential reduction in IPOs that has caused some to worry; initial listing fees accounted for less than 1.5% of Nasdaq’s record 1.7B in 2006 revenue. The success and growth of Nasdaq comes down to three simple words: volume, volume, and volume.

And the long-term growth of trading volume is one trend that we can count on. The World Federation of Exchanges has some great data showing the incredible growth of exchanges since 1990. Just for illustration, the value of shares traded on the Lima Stock Exchange (Peru) has increased 55-fold, while the Tokyo Stock Exchange has increased 600% despite a lackluster economy. Even own own mature financial market grew overall volume by 25% in 2007 alone. And if that’s not enough to juice growth, new exchanges in emerging markets like Vietnam, Colombia, and even some African countries are beginning to take hold.

The opportunity for the largest exchanges like Nasdaq and NYSE Euronext to consolidate this fast-growing and fragmented space is obvious. Economies of scale are especially valuable in the exchange business, where trading is done by computer networks that require large fixed costs. Consolidation can lower trading costs, which attract more traders and listing companies. Larger exchanges also create increased liquidity, helping share prices move more quickly and efficiently.

As expected, we are seeing a lot of acquisitions, with NYSE buying Euronext and AMEX, and Nasdaq buying OMX (Nordic exchanges) and the Philadelphia and Boston exchanges. It looks like we are indeed moving towards the vision presented last year in The Wall Street Journal: “The accounting world has the Big Four. The auto sector had the Big Three. And stock exchanges, once a fragmented industry with dozens of players, may be headed toward a Big Five or Six.” Nasdaq has announced that it will spend 2008 integrating its three acquisitions, but will again be on the prowl for new buys in 2009.

Nasdaq’s recent deal with Borse Dubai perhaps foreshadows things to come. As part the OMX acquisition, Nasdaq and Borse Dubai traded stakes in their respective companies. The Dubai Exchange will be re-branded as the “Nasdaq DIFX” and will leverage Nasdaq’s software platform for expansion. It’s a promising development that the world’s next great financial center places immense value on Nasdaq’s platform, brand, and expertise. As the global economy continues to grow, more emerging markets will no doubt see value in partnering with the market leader.

Not only is the size of the pie growing, but Nasdaq appears to also be doing a good job taking a bigger slice from competitors. Last year, Nasdaq became the largest U.S. exchange, processing 29% of all equity trades in December, up from 27% in 2006.

Nasdaq reports earnings before the market opens this Thursday. I would use any negative market reaction or near-term weakness to pick up more shares, as this is a long-term story that is just starting to play out…

Disclosure: SmartGuyStocks is long NDAQ

PETS a bright spot during market downturn

Despite the market taking yet another hit, SmartGuyStocks selection Pet Med Express (PETS) gave us something to smile about, shooting up over 20% yesterday. PETS beat analyst expectations for its third quarter as earnings rose 60% on the strength of a 19% jump in sales. The company also continued to deploy its strong cash position towards buybacks, purchasing 1% of the float in the quarter.

While the company has yet to release detailed financials, we can guess that overall margins improved due to the strength of re-orders and internet sales, which both outpaced overall sales growth. These are extremely positive trends for the company. Re-orders indicate that customers are happy and the company may be able to rely less on Betty White and more on word-of-mouth advertising. Online growth means that customers are moving away from the more overhead-intensive phone ordering.

Hopefully, yesterday definitively proved to investors that PETS is not a consumer discretionary stock. Note the contrast with leading pet retailer PetSmart (PETM), who last night slashed its forecasts on weak consumer spending. As I have been saying repeatedly, consumers increasingly think of pets as members of their families, and medications for family members are necessary purchases. PETS will continue to profit from this whether or not there is a recession, and we will continue to hold our shares.

Disclosure: SmartGuyStocks is long PETS

SGS Five Investing Pitfalls: #2 Buying “cheap” stocks

I wish I had a dime for every time in the last month I’ve heard a market commentator argue that a beaten-down stock is a buy solely because it is “cheap.” Maybe with all that money, I could pay investors back for all the money they’ve lost buying these supposedly bargain stocks.

At a recent visit to a bookstore, one of the financial publications was touting Wachovia (WB) as a buy at 40. The logic was basically “the stock has gone down a lot already, the PE is only 9, and it pays a 6% dividend while you wait for it to go up.” This might make sense if:
1) The stock hadn’t gone down for a good reason (write-offs, and an uncertain credit and banking market) and
2) Future earnings and dividends are guaranteed (many on Wall Street worry that WB may cut its dividend and earnings forecasts like other banks)

But the magazine didn’t mention these caveats, nor even attempt to give any catalyst for upside to the stock aside from the fact that it was “cheap.” Well apparently the market didn’t think so, and the stock is down another 20% in a matter of weeks.

While WB may yet end up being a long-term buy at 40, the reason is not because it was “cheap”. Rather, its business or the overall economy will have improved. With financial stocks in the toilet and nearly everyone jumping on the recession bandwagon, this is not the time to buy something without strong conviction. Investing 101 dictates that no matter how bad things may seem, they can always get worse.

Why try to guess the bottom instead of waiting for at least a modicum of evidence that things are turning around? Ask the Caylon Securities analyst who kept a “Buy” rating on Capital One (COF) despite its recent earnings warning (he’s had a buy rating on the stock since $80!). “I think it’s dead money for a while. I think that if you bought this stock at $40, in two years, you’d be happy if you did.” And yet he still recommends buying it now? Personally, “dead money” didn’t make my list of top investments for 2008.

Similarly, shorting a stock simply because it appears expensive can be a similar exercise in futility. Just look at the run of Salesforce.com (CRM), which looks pricey by almost any metric. And it’s been practically a daily ritual for someone on Seeking Alpha or another investing site to call the top on white-hot solar stocks like First Solar (FSLR). As you can see by the chart, it’s a dangerous exercise trying to get in front of the hype train.

As evidenced by our success in shorting Build-A-Bear Workshops (BBW), sometimes shorting “cheap” stocks can be the most lucrative. Wall Street is no different from any other market- too often you get exactly what you pay for.

At SmartGuyStocks we hate leaving money on the table. Too often, popular beliefs about investing lead to that result. We have identified five common mistakes that investors make. Stay tuned for the next three installments of “SGS Five Investment Pitfalls.”

2007: SmartGuyStocks Beats Market 30.2% v. –2.6% and Learns Two Lessons

When we created SmartGuyStocks in June 2007, our goals were simple:  First, make money for our readers. Second, publish articles interesting enough to actually have readers. Despite less than seven months of operation, 2007 was unequivocally a success on both fronts. Our picks have gained 30.2% vs. a loss of 2.6% for the S&P 500. SmartGuyStocks now has hundreds of direct subscribers, with thousands more reading feeds through Seeking Alpha and Yahoo! Finance. To all of you, we say thank you and hope to bring you another fun and profitable year!

Despite our success thus far, we are always looking to learn from experience and refine our investment strategies. In the spirit of reflection and resolution, here are the two biggest lessons we learned in 2007:

1. Trust your eyes and ears

While financial analysis is important, we’ve learned there are occasions when real-world observations can overpower traditional definitions of a “cheap” or “expensive” stock. At SmartGuyStocks, we have a proven ability to spot companies poised to make a move simply by following Peter Lynch’s famous tried-and-true mantra: “Invest in what you know.”

So when we heard everyone we know pining for a Wii and had no success finding one ourselves after calling over 30 stores, we jumped at the chance to buy shares of Nintendo (NTDOY). Likewise, when we personally experienced Blockbuster’s (BBI) ill-fated Total Access program, we bought puts. When we saw Martha Stewart (MSO) falling out of the national spotlight and her flagship magazine discarded in favor of Real Simple on coffee tables, we knew shares of her company would follow.

However, we missed additional successes because we were hung up on traditional notions of valuation despite witnessing strong real-world trends. For example, we observed and identified the growth and popularity of retailers Lululemon (LULU) and American Apparel (APP) before each went public, but we dragged our feet buying shares because they seemed too pricey. We take solace in the fact that there will be many similar opportunities in the future; and rest assured, we will no longer second-guess what we see and hear. We have learned it is better to start a small position in these “expensive” stocks rather than miss the boat. If these picks have the potential to become 5-10 baggers or better, then a small position can still yield awesome results.

2. Intelligently buy and hold

Time and time again, retail investors are reminded to “buy and hold.”  Investment writers urge us to sit tight through all the ups and downs, no matter what. Pick good companies, close your eyes, and check the Wall Street Journal again in 30 years to count up your riches. While I certainly do not want to break with this established canon of stock market strategy, I think that investors are leaving money on the table if they are not practicing “intelligent” buy and hold.

Intelligent buy and hold dictates that you regularly follow your investments and look to act on major news or price moves. For example, we recommended Radvision (RVSN) as a play on the growing demand for videoconferencing. But we immediately sold when this “growth” stock cut third quarter sales and earnings guidance twice and admitted it was losing market share due to a missing product feature. Despite taking a loss, we prevented an additional 25% downside that a traditional buy and hold investor would have realized.

Similarly, when small-cap industrial distributor DXP Enterprises (DXPE) announced earnings that fell just short of expectations in July, we re-examined our position in the company. Despite the 35% share price drop, we couldn’t find much wrong with the company’s fundamentals. Although earnings missed expectations, these were expectations set by a paltry two analysts who track the stock. Further, profits and sales still grew tremendously over 2006, and management reiterated they were seeing strong demand and expected enhanced growth going forward. With our investment thesis still in tact, we took advantage of the market overreaction and doubled-down on the stock. The next quarter’s earnings were as strong as management predicted, and we later sold this stake for a huge 42% gain in four months.

Going forward, we will continue to see large price drops or gains in our holdings as an opportunity: a chance to cut losses with a negative story, or add to our position with positive news or a market overreaction. While buy and hold can be profitable, intelligent buy and hold can be downright lucrative.

With these two new lessons in the trading diary, we look forward to a very successful 2008! Thanks again for all your lively feedback and support!

Sincerely,

SmartGuyAB & SmartGuyDH

www.smartguystocks.com

Martha Stewart Living is not a growth stock

Since I recommended buying puts on Martha Stewart Living (NYSE: MSO) last month, shares have tumbled more than 5% as the broader market has rallied. Yet despite this minor correction, the market is still pricing MSO as if it were an exciting growth stock, not the dying brand milking its core followers for every last penny that it really is. Recent developments reinforce the fact that this stock does not deserve its current 22 forward multiple or 2.7 P/S.

First, there was the apparently upbeat announcement that The Martha Stewart Show would be picked up by NBC/Universal for a fourth season in syndication. You had to actually read the entire press release to see the bad news that the show would now only be syndicated in 60% of the country versus the current 95% for season 3. The surprise here is that the show was actually renewed given its dismal ratings: during November sweeps, the show garnered just a 1.1 rating, a 20% drop from last year. This put it behind Jerry Springer (1.4) and just ahead of Judge David Young (0.9). Archrival Rachael Ray scored a 2.1.

Then came word that the company would shutter its Blueprint magazine. According to the company, the magazine was “Geared to women ages 25-45, Blueprint targets a different demographic than our core consumer…thereby broadening our advertising reach.” Like nearly every other effort MSO has made to expand its reach (The Apprentice, KB Homes, K-Mart), Blueprint was a disappointment. The company is placing new bets on recent deals with Macy’s and Costco, but the success of these new partnerships remains to be seen. MSO’s revenue from K-Mart will drop by over $40M in 2009, so it will have a lot of ground to make up.

I give Martha Stewart credit for finding a successful niche. She is a hero to my mom and millions like her. Yet there is only so much Martha that this core market can consume, and I believe it has nearly reached its saturation point. Every attempt to expand her brand to other demographics has flopped, and she has been replaced as the “it” homemaker by Rachael Ray. I have no doubt that MSO can profitably milk its loyalists for steady revenue during the next few years before its 66-year-old namesake decides to retire to the tropics. But there is absolutely no reason for this company to be priced as a growth story.

Disclosure: SmartGuyAB owns MSO puts

DXPE’s third quarter brings redemption

The last week in October was a good one for SmartGuyStocks. Two-time pick DXP Enterprises announced third quarter earnings that trounced analyst expectations, sending the stock up over 15%. The announcement must have been extra sweet for DXPE CEO David Little, who just months prior was derided as a bumbling idiot as he struggled to account for the second quarters’ “unexplained” June sales softness.

Little feebly tried to mention that DXPE still expected top-line growth of 30+% in the third and fourth quarters, and that the acquisition pipeline looked stronger than ever, but the analysts had apparently already checked out. Disgusted that DXPE had “only” reported 22% sales growth, they sent shares down over 25% in one day. At that point, we decided to re-recommend DXPE at a bargain price in the low 30s. It looks like Little has been true to his word, first by landing a major acquisition of Precision Industries, and then by announcing a 56% increase in third quarter sales and a 25% jump in EPS. He also noted that the Precision acquisition has been exceeding expectations, expediting DXPE’s ambition to be a national distribution powerhouse.

Now that Little has redeemed himself to his critics, at least temporarily, it’s back to the thankless work of consolidating the industrial distribution industry.  I continue to recommend buying on any weakness as we watch this growth story continue to progress. This is going to be fun.

Disclosure: SmartGuyAB is long DXPE

Akamai continues to defy analyst worries

Akamai (Nasdaq: AKAM) reports 40%+ growth and announces strong forecast, analysts worry. It’s the same old story, and one that I believe will ultimately reward AKAM shareholders. I first made AKAM a SmartGuyStocks pick in August, after the company reported stellar earnings yet got crushed due to unfavorable analyst comments. At that time, a variety of analysts bemoaned AKAM’s future, insisting that the days of fast growth and high profit margins were over due to major competition. Later that month, those analysts smiled with glee as competitor Limelight announced a new deal with Microsoft.

But rather than signaling the end of AKAM’s growth run, these moments were actually great opportunities to gobble up shares on the cheap. Despite all the predictions of doom and gloom, CEO Paul Sagan stepped up to the podium last week and announced yet another brilliant quarter of explosive growth, high margins, and low churn. Said Sagan, “We were very pleased with our third quarter results and the demand we saw for our services, especially as we experienced increased momentum during September.” Not exactly music to the ears of naysayers.

Yet some people just never learn. Several analysts came out again and reiterated their concerns about increased competition. As long as the demand for digital content delivery continues to grow and AKAM continues to execute as the industry leader, the analysts can agitate all they want. Like its fellow Boston- area residents, the New England Patriots, you can count on Akamai to regularly deliver spectacular
results.

Disclosure: SmartGuyAB is long AKAM

PETS still lapping up profits

On Monday, SmartGuyStocks recommendation PetMed Express (Nasdaq: PETS) reported excellent second quarter results. Revenue rose 18% to 51.5M while net income jumped 37% to $0.18 per share, both exceeding analyst estimates.

These results are especially impressive in light of the recent disappointing results at Petsmart (Nasdaq: PETM), who blamed its shortfall on an uncertain economic environment, consumer weakness, and bad weather (yeah, I don’t get the last one either). But PETS is in the market’s sweet spot- while consumers may pinch pennies and hold off on buying a fancy new birdhouse from Petsmart or Petco, buying Fido’s heartworm drugs is non-negotiable (and as I wrote about in my original recommendation of PETS, so too could soon be his Prozac and weight-loss pills).

In fact, in an uncertain economic environment, PETS will actually thrive, as it provides an essential product at a much lower price than the neighborhood vet. This is demonstrated by the fact that sales zoomed while advertising expenses barely budged vs. 2006. Growth of reorder sales was 25%, indicating that PETS is producing satisfied customers, while further supporting my thesis that the people are increasingly willing to seek aid for more pet ailments. Throw in some strong cash flow and $1M in share buybacks, and its fair to say that PETS was a “good boy” for the second quarter.

Disclosure: SmartGuyAB is long PETS

Getting rich off looneys and twoneys

While most college students have to wait for their 21st birthday to (legally) drink and gamble, students at the University of Michigan have had it a lot better. That’s because Ann Arbor is less than a hour’s drive from Windsor, Canada’s version of Las Vegas- where an ID stating you are 19 is a passport to a college student’s Eden. Windsor features a large casino and a lifetime’s worth of bars and strip clubs stocked full of Molson and Labatt. But the best part, when I was there, was that everything in this fantasyland was 25% off - we could trade in our dollars for a king’s ransom in Canadian looneys and twoneys.

Unfortunately, today’s Wolverines no longer have it so good. For the first time in my lifetime, Americans crossing the border actually have to pay a premium - each dollar now gets you only 96 Canadian cents. But don’t cancel that Saturday night trip to Windsor quite yet - you can more than make up that 4% premium by buying the stocks that stand to benefit from the current currency situation.

The last few years have brought success for American companies with large export operations, especially to Europe. One of my favorite companies, Hurco (Nasdaq: HURC), which I wrote about in August, has seen its stock increase more than four-fold, in part due to favorable exchange rates for European sales.

But over the past quarter, it has been the Canadian dollar that has been on a tear. The graph below compares the strength of the Euro and Looney relative to a dollar over the last three months.

This presents an enormous opportunity with the arrival of earnings season. Companies that derive a large percentage of their revenue in Canada and report earnings in US dollars should see an earnings spike. Case in point: retailer Lululemon (Nasdaq: LULU), who has a majority of its stores in Canada, has seen its stock skyrocket after pre-announcing strong quarterly sales, owing in part to currency translation.

I’ve been racking my brain trying to find the next LULU. So far, the best I’ve been able to come up with are specialty foods producer Sunopta (Nasdaq: STKL) and trucking company Vitran (Nasdaq: VTNC). Both are Canadian companies who report sales and earnings in US dollars. However, revenue from Canada make up less than 1/3 of both companies’ sales. I’m going to keep looking, and I ask our readers to weigh in with their ideas. Let’s make sure Michigan students can continue to celebrate their 19th birthdays alongside their Canadian friends.

Disclosure: SmartGuyAB is long HURC