Home Depot and Lumber Liquidators
Netflix (NFLX) stock surged 11.4% last Wednesday, on big volume, as the company released some encouraging data about its customers' embrace of video streaming, stating, "More than 20 million subscribers worldwide watched more than two billion hours of old TV shows and movies on devices with high-speed Internet connections during the final three months of last year."
On Thursday the stock paused, but on Friday it surged again, to its highest level in a month, on even greater volume.
And that raises the question, "Is it time to get back into Netflix?"
After all, the stock is 72% off its highs of mid-2011 when it alienated customers by raising prices and then goofed (big-time) by announcing and then cancelling a plan to separate its DVD-by-mail and video streaming business. Having lost $12 billion in valuation since then, Netflix looks cheap to a lot of investors; in fact some view it as a takeover target, citing Amazon (AMZN) and Yahoo (YHOO) as potential buyers.
They might be right.
But I don't advise investing in NFLX now and here's why.
As a rule of thumb, once a very popular hot stock (or sector) falls from favor, it takes far more than six months' time to make it an attractive stock again; it usually takes two years or more ... long enough for investors to forget about it. (Remember those solar stocks of 2007?)
Today, with Netflix's decline still very fresh, too many people are looking for an opportunity to get back in, and the market is seldom so accommodating. In short, I think it's plain early.
Furthermore, Netflix, which lost roughly three million customers last year, is expected to lose money in 2012, for the first time in a decade. That ruins the firm's beautiful record of sales and earnings growth, and that might put a crimp in the spreadsheets of interested investors.
Finally, I believe founder and CEO Reed Hastings would resist any takeover attempt. Netflix is his baby, which he raised perfectly until this past year, and I believe there is more he wants to do with it.
Again, I could be wrong. But the odds are that money invested now will do better in lower-profile stocks with better risk-reward prospects, such as the one I recommend below.
But first, a story.
Twenty-five years ago, when my wife and I built our home on a shoestring budget, we carpeted the bedrooms with a synthetic blue fiber. It proved quite durable, but as the decades passed, it grated on my wife's aesthetic sensibilities.
So a little more than a year ago, I replaced one of the carpets with a hardwood floor, doing the work myself, and this past New Year's weekend I set about to replace the other.
I picked up the wood, prefinished Brazilian cherry, at a nearby Lumber Liquidators store, on sale on the last day of the year.
And I rented the floor-nailer from Home Depot ... which is where the story gets interesting.
It was 9:30 in the morning on New Year's Day. To say Home Depot was uncrowded would be an understatement.
At the Tool Rental Center, staffed by an indifferent young man, I surveyed the floor-nailers and selected a manual model, just like the one I'd used previously. The cost was $35 a day. I asked for help choosing nails; the kid asked what size I wanted; and when I replied, "Inch-and-a-half," he selected a box and added it to the pile.
Here's a picture of the nailer.
A few minutes later, paperwork complete, I was headed home. And several hours later, I was thoroughly frustrated, as roughly half the nails I tried to drive into the floor failed to go in properly. Sometimes the plunger would halt partway and get stuck, necessitating a tedious unjamming procedure. Sometimes two nails would be delivered at once. Sometimes it would work just fine. But I was spending a lot of time wrestling with the nailer, wondering what I was doing wrong.Eventually, I sat down to read very carefully, and that's when I saw the problem. The nailer was designed for 16-gauge nails, but the kid at Home Depot had sold me 18-gauge nails!
Luckily, when I returned to Home Depot and explained all this to the attentive older gentleman then staffing the desk, he was very sympathetic. In fact, he was so understanding that he charged me nothing for the first nailer, AND he provided the use of a new pneumatic nailer, complete with compressor (a combination that normally goes for $67 per day) for free!
And as we were completing the arrangement, I heard his co-worker remark, in reference to the kid who had given me the wrong nails to start with, "This wouldn't happen if he'd stop playing with his phone and look at the tools instead."
I kept my mouth shut, took the new nailer home, with the correct nails, and many hours later, had a beautiful new floor.
So what's the point?
First, Home Depot is a great resource, provided you know what you need, or can find an employee to help determine your needs ... and usually you can. The wealth of experience in the brains of its older staffers is priceless, and I'm confident the kid stuck working the New Year's morning shift is an anomaly.
But Home Depot (HD) is no longer a great investment. Years ago, from 1993 to 1996, Cabot Market Letter subscribers enjoyed a 300% profit in the stock as the company crossed the $10 billion in annual revenues level. Today the company is a behemoth, grossing some $70 billion a year, and struggling to return to the $81.5 billion it grossed in the year before the housing crisis hit.
In short, Home Depot is no longer a growth company. And it's not a good value investment, either. Roy Ward of Cabot Benjamin Graham Value Letter says the stock is fully valued at 42 and should be sold.
As to Lumber Liquidators (LL), we've never recommended the company, and it's never been a particularly popular stock, judging by its trading volume. Even now, with annual revenues topping $600 million, and capping a perfect 10-year record of growth, average daily trading volume is just 450,000 shares. In short, institutions aren't interested.
The stock does look cheap, however, trading 50% off its high of 2010, with a market capitalization of just $501 million, so an investment here may well pay off. We like the cookie-cutter model of growth, which consists mainly of opening more stores -- Lumber Liquidators now has 223 stores in 46 states, and there are more on the way. But profit margins have suffered in the past six quarters, and there may well be worse ahead.
But there are some attractive stocks today in the housing industry, and a key reason for the strength is illustrated by the chart of Housing Starts below.
The industry has bottomed. The rebound has begun. For the average stock, it's been more than five years since the selling started (unlike the six months for Netflix), so these stocks are long forgotten by most investors. And the upside potential is so large, for both the industry and individual stocks, that it's worth examining the stocks that are acting best in coming off the low.One of my favorites is Toll Brothers (TOL), which styles itself "America's Luxury Home Builder." Toll Brothers is now operating in 20 states, selling homes that go for an average of $606,000. It was absolutely hammered in the industry's collapse. Sales fell from $6.1 billion in 2006 to $1.5 billion in 2011, while a profit of $4.73 per share in 2006 turned into a loss of $0.87 per share in 2008 before rebounding--thanks to widespread cost reductions--to a profit of $0.24 share in 2011.
Toll was featured in Cabot Top Ten Trader back in November. Here's what editor Mike Cintolo wrote:
"There might not be a sector that's as unloved as the homebuilders. After all, the stocks have been dogs for about five years now, and all the news surrounding the industry is poor ... However, with new home construction in the U.S. sitting near 50-year lows (!) even as mortgage rates are at all-time lows, and with most homebuilders having cut costs to the bone, it wouldn't take much of an uptick in housing activity to cause earnings to rise significantly. Toll Brothers has always been the class act of the industry, focusing on the top-end of the market, and while business has been so-so of late, management has begun to speak more positively ... We think Toll and other homebuilders could be interesting speculations once the market finds its footing. As with just about every Top Ten stock, TOL has been choppy of late but continues to trade miles above its panic low in October. Moreover, selling volume has been tame after a solid-volume ramp up during the recent rally. If you're aggressive, you could buy some around here with a loss limit of two points."
Mike gave it a recommended buy range of 18-19.
Since then, Toll has announced (on December 6) its third quarter results, which were encouraging. I particularly liked the words of Robert I. Toll, executive chairman, who stated: "We believe that a strengthening of the housing market is key to an economic recovery. It will reduce unemployment, which will improve consumer confidence and bring on more demand."Unemployment nationally among college graduates is well below 5%. We, therefore, believe that our customers have the ability to buy. They are aware of the tremendous affordability of homes and the record low interest rates. However, a lack of confidence in the direction of the economy is perhaps the biggest impediment to releasing what we believe is significant pent-up demand."
TOL is now trading around 22, meaning investors who bought in Mike's suggested range back in November are up at least 15%. And they continue to be updated on TOL's status every week, while receiving other high-potential recommendations, every Monday.
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Yours in pursuit of wisdom and wealth,
Cabot Wealth Advisory
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