Jason’s Portfolio April 2016

I thought it my be useful for myself and others if I list out the stocks in my portfolio and watch list. I have informal categories for each stock I own based on whether I’m looking to buy, hold, or sell. I’d like to make those categories a bit more formal in this post and going forward.

The “Method”

There are really two things I’m tracking here for each stock in the portfolio.

One is what mode I’m in with regards to the stock; whether I am watching, buying, holding, or selling the stock.

The second item tracked in this list is the value of the stock; if I think the stock is undervalued, fairly valued, or overvalued.

Note that the mode is not a recommendation. It’s just how I am personally approaching the stock. The mode I list is based primarily on how large my position is in the stock. If I say I am “buying” a stock, I could be buying it right now if it’s undervalued or I might be waiting for the price to fall (sometimes as much as 50%) before getting in. Similarly, if I list the mode as sell, it just means that I have too much of that stock and need to find the right time and price to sell.

The Value on the other hand can be considered my opinion of whether a stock is a good buy or not based on the current price. I am not a professional… disclaimer disclaimer… I should really get the correct language to keep people from suing me… but if I say something is undervalued I think the stock price is going to be higher 5 years out and if I say it’s overvalued I think the stock price is going to be unchanged or lower 5 years out.

Here are the categories again.

Mode

  • Watching
  • Buying
  • Holding
  • Selling

Value

  • ? (Need to research more.)
  • Undervalued
  • Fairly valued
  • Overvalued

Ideally I will be buying stocks when I think they are undervalued and selling them when they are overvalued, but whether I am buying or selling depends on some other things.

To skip to the list, you can load the Google Spreadsheet here. Or read below for an explanation of each “mode” and “value” category.

Modes

The “mode” I list for each stock is not a recommendation to buy or sell. It’s simply how I am approaching a stock. If I say I am “buying” a stock, I am really looking to buy. It just means I wish I owned more of this stock. I might be buying the stock at the current price or just as often I will be waiting for a stock to pull back (maybe as much as 50%) before really committing to it.

Similarly, if I say I am “selling” a stock, I may be selling it right now but just as often I am waiting to sell it. This really just means that I have more of this stock than I need and I could sell some to purchase stocks that I think are undervalued. I am almost never selling 100% of my position in a stock.

Here are some more details on each of the above “modes” I might be in with regards to the stocks in my portfolio. At any given time I’m either watching, buying, holding, or selling.

Watching

These are stocks that are on my radar, but I haven’t yet invested in. They might be a company that I am confident in, but need to do more research on to find a fair price to buy the stock at. Or they are a stock that I think is “on sale”, but I need to do more research on to find out if the underlying company is strong.

Buying

These are stocks I am looking to buy more of. Usually I am buying when the stock is also undervalued, but I’ll sometimes open positions in stocks when they are fairly valued with the hopes that they will drop further.

When buying, I try to open a 25-50% position and then buy in 25% chunks for each 10-20% drop in stock price. So if I had $10k to put toward a position, I would open a position with $5k and then buy another $2.5k when the stock price dropped, and another $2.5k if it dropped further. These are rough numbers. The specific numbers will depend on the particular stock and situation. But I’m generally dollar cost averaging into these stocks as the price bottoms out.

Holding

These are stocks that I am invested in and holding. I’m not buying more, either because my position is too large a % of my total portfolio or because the stock is fairly valued or slightly overvalued. I’m not selling either because in general I’m more interested in acquiring as much stock as possible in companies I think are strong vs trying to make “trades”.

Selling

These are stocks that have run up for me and I’m looking to sell. I generally won’t sell stock unless I need the money to purchase something else that is on sale (from my Buy list) or I think the market is heading downward and I want some cash to hunt for opportunities.

Value

How do I determine if a stock is undervalued, fairly valued, or overvalued? In general, I try to guess how much revenue a company is going to be making 5-15 years out and figure out what a fair price would be assuming they get there and then discount that price based on risk factors. I use an analysis similar to what Phil Town does in his book Payback Time. You can see an example of that kind of analysis I did for GOOG here.

The list below will contain just one word, but behind that is typically a lot of research, earnings calls listened to, model spreadsheets, and deep thinking about the technicals and fundamentals of the stock and company. I also try to do some “main street” thinking by considering what the company actually sells, how much they think they are going to sell and at what margins/etc. It’s awesome to see a company like Apple growing at 25% per year, but are there enough people in the world to buy enough iPhones for them to double their revenue again?

Here are some general thoughts about each category of value.

? More Research Needed

If its been to long since the last time I researched a stock, I’ll put a ? in the value column. Maybe the stock price has run up and I’m not sure if it’s still undervalued. Maybe a few earnings reports have come in and my numbers need to be updated to take new numbers and growth rates into account.

Undervalued

These stocks are either mature companies with low PEs or revenue multiples (like Apple) or young companies where (in my opinion) the market is undervaluing the future earnings potential of the company (like Tesla). If a stock is in this category, I generally expect it to grow 2-4x over the next five years.

Unless I already have a large position, I should be looking to buy more of these stocks. If you asked me for a “stock tip”, these would be the stocks I would talk about.

Note however that undervalued doesn’t mean “will not fall in price”. Stock prices can always go lower, especially stocks that have had a good run recently. Stocks that are up 100% over the past year could still be undervalued. You’ll just have to be more careful when buying them (i.e. dollar cost average).

Fairly Valued

These stocks are priced about right based on the models I’m using. I’m generally holding these stocks and letting them run.

Over Valued

These stocks are highly priced (or “frothy”) based on the models I’m using. These are probably “momentum” stocks that the market is taking higher and higher. I’m generally letting my winners run, but if I need cash to purchase more of a stock in the undervalued category, these are the stocks I’m going to sell first.

My Portfolio

These are stocks that are on my watch list or stocks I own some amount of in my retirement account, my wife’s retirement account, or a couple of personal accounts I hold in my children’s names. For each, I’ll say what “mode” I’m in for that stock and how I think it’s “valued”. A “?” in the value column means that I need to update my research based on the current stock price and fundamentals.

I’ll keep an updated spreadsheet of this portfolio in Google Docs publicly here. Or you can see the list from the time of this blog post below.

Company Ticker Mode Value
Activision Blizzard ATVI Hold Fair
Amazon AMZN Buy ?
Apple AAPL Buy Undervalued
Disney DIS Hold ?
Google GOOGL Hold Fair
Hasboro HAS Hold ?
Netflix NFLX Hold Fair
Nintendo NTDOY Buy Undervalued
PayPal PYPL Buy ?
Solar City SCTY Buy Undervalued
Starbucks SBUX Hold ?
Square Enix SQNXF Buy Undervalued
Tesla TSLA Hold Undervalued
Take Two TTWO Hold ?
Twitter TWTR Buy Undervalued
Zynga ZNGA Buy Undervalued

Notice that this is almost 100% technology stocks, which does leave me undiversified by industry. However, technology companies are something I feel I have a lot of domain knowledge over which helps me to pick the winners. We also invest part of each of our accounts in total market and world market index funds.

When does Twitter Stock become cheap?

twitter-bird-white-on-blue-300pxI’m reading the book Sapiens: A Brief History of Humankind by Yuval Noah Harari. In a section on the Agricultural revolution, Harari reminds us that while farming allowed human populations to grow, the quality of life for the average farmer was worse than the average hunter-gatherer. Farmers worked longer hours, with worse health, and generally lived more repetitive (and possibly more boring) lives than their hunter-gatherer counterparts.

Still, living in cities with farms to work on meant more babies, which meant more people with more reason to cooperate, leading over the years to the complicated network of nations and societies we live in today. Similarly, are modern day humans are working harder than our ancestors worked. Are we living longer, but less fulfilling lives?

It’s unclear to me whether tools like Twitter, which are taking up more and more of our precious time, are making our lives better or worse. It does seem to me however, that Twitter and the Internet in general are bringing people together cognitively in the same way that farms brought people together physically. While sporting events, movie launches, wars and riots happen in different places all over the globe, everyone can share in these experiences in the same virtual space in real time scrolling through Twitter feeds 140 characters at a time.

What does this have to do with Twitter as a company and stock? I’m not sure, but hopefully we can come together here to figure out if Twitter is a good investment at $22.45 per share.

Twitter (TWTR) stock is trading at around $22.45 a share right now, putting it at a market cap of $15.7 Billion. They have about $4B in cash, revenues of $2-$B, and trailing 12 month earnings per share of -$0.86 (negative 86 cents). Twitter IPO’d around $45 per share, hit an all time high around $75 per share earlier this year, and has since tumbled to the current price.

Is Twitter stock cheap yet?

The answer to this depends on what metrics you are using for valuation. Technology companies like Twitter, which have ubiquitous use but indirect methods of making money, are especially hard to value. I’ll try my best.

For mature companies there are two benchmarks that I like to use when valuing a company. (1) A price to earnings ration (PE) of 15. (2) A market cap that is 2x revenue.

Why these numbers? I think that’s a good topic for another post or ten, but in short a PE of 15 is roughly the long term average PE for the entire stock market. Similarly 2x revenue is fairly average for companies across industries and maps pretty well to the 15 PE if you consider an operating margin around 10-20%.

These numbers are most definitely rules of thumb and shouldn’t be held sacred, however they are a good starting point for analyzing a stock. If a stock doesn’t trade at a 15 PE or 2x revenue, that is normal and expected, but you can learn a lot by asking WHY the stock is trading at a different PE or revenue number. Is there something structural about the company that makes it more or less profitable than others? Or, as we’ll find is the case with Twitter, do we need to wait around for revenue growth to justify the market cap.

Where does Twitter stand from a revenue and PE perspective? As of writing…

Stock Price: $22.45
Market Cap: $15.7B
PE: N/A (negative  86 cents per share earnings)
Revenue: 7x Revenue (estimated $2.2B in 2015)

Not looking good, but let’s ask why the PE is negative and why the revenue multiple is so high.

Why is the Twitter PE negative?

Twitter is spending more money than it makes. Obviously this can’t be sustained, but it makes sense for young companies that are transitioning from a user growth phase into a revenue growth phase.

Twitter earnings are also hard to figure out due to the large amount of stock options they use to compensate their employees which makes for a large difference between their GAAP (generally accepted accounting principles) and non-GAAP (shit we just made up) earnings numbers. This post is from 2014, but explains the difference in Twitter’s case pretty well.

As an aside, non-GAAP numbers are fine in principle and often help investors to understand special cases with regards to how a company is making money. More and more companies though are paying their employees in stock options, effectively moving that expense off the books by using non-GAAP numbers or diluting outstanding shares. It makes our job as investors harder.

The bottom line for Twitter’s PE is that negative earnings are obviously bad and if you invest in Twitter, you have to have some expectation that earnings will turn around at some point in the future. Hopefully sometimes soon before cash reserves run out. The good news is that Twitter’s earnings are trending up and future estimates are positive.

Specifically, to justify a $15B market cap at a 15 PE, Twitter would need to generate earnings of $1B per year. As we’ll see below, getting to the revenue and operating margin to bring in $1B in earnings should be very doable for Twitter a few years out.

Why is Twitter’s revenue multiple so high?

Twitter is currently trading at 7x revenue, which is above our 2x revenue benchmark. Why?

Again, Twitter is growing and investors know this. The 2x benchmark is for a mature company, i.e. one that is not growing or growing slowly. Twitter revenues are growing somewhere north of 50% quarter over quarter and year over year. At these rates, $2B in revenue in 2015 becomes $3B in revenue in 2016, $4.5B in 2017, etc.

The obvious next questions are if current growth rates can last (hint: they never do), how they will trend in the future, and if the company will be able to make a profit on those future revenues.

How big can Twitter revenue grow?

I’ll use a really simple method to calculate further revenues, which I’ll call “Twitter will make as much money as Facebook does”. More specifically, I suspect that Twitter will be able to make as much per user as Facebook is.

Anecdotally, Twitter’s new “put a sponsored tweet where you expect to see replies or click to reply” tactic is super annoying and probably making bank for them. I expect their revenue to beat in their next earnings report.

Facebook has about 4x the number of monthly active users (1.2B vs 300mm) but is making 8x the revenue ($17.4B vs $2.B). I believe that Twitter can close the gap and should be able to make at least $4.4B from their 300mm users. This would put their revenue multiple at a respectable 3x. If we expect their user numbers to grow as well, they can very reasonably reach a 2x revenue multiple in 2-4 years.

A 20-25% profit margin (reasonable for an Internet services company) on $4.4B in revenues leads to ~$1B in earnings or that 15 PE we’re looking for as well.

We’re just doing math here, so it’s important for everyone to do their own homework to see if they think that these numbers we end up with make sense. The particulars of each company, what I would call “Main Street Analysis”, will tell you in the numbers make sense. In practice that might look like a lot of reading of earnings reports, other analysis, or general knowledge of how the business works. In our case, we’re being lazy and just saying that Twitter will have a similar trajectory that Facebook has had since IPO.

So is Twitter cheap?

Based on this analysis and the expectation that Twitter can get to $4.5B in revenue and grow respectively from there, Twitter is about fairly valued and just starting to get cheap. So I personally am considering starting a position with the expectation to add more as the price drops. I’ll probably purchase shares in my children’s brokerage accounts. (Christmas money for the win.)

If you expect Twitter to grow into more than just a platform to show ads occasionally to 300m people, you can basically get all of that extra stuff for free. The current price is inline with the straight forward, low risk, advertising business Twitter has now. So any extra revenue from Periscope, premium services, digital ID fees, or spoils collected from the governments it overthrows is gravy.

In my opinion, Twitter is very much an integral part of our society. When news happens, it happens on Twitter first. Facebook is starting to work like Twitter in this way, but I don’t see it overtaking Twitter without losing all of the other stuff we like about Facebook. The hole quick, 140 character, nonchalant nature of Twitter is actually exactly what makes it work so well. And considering they are ingrained in every news organization, business, and with every celebrity, I don’t see another service overtaking them without warning.

Assuming the general market doesn’t suffer a pull back, Twitter should be free of any new “bad news” that could move the stock lower. Weak investors should be shaken out soon, and if Twitter continues to grow as I expect it to, I suspect a slow rise with each new earnings report. Look for the stock to trade a bit lower, but turn around soon, and then rise up steadily from there.

 

Apple. When are the fundamentals of the stock ever going to take charge of its price?

This post is inspired by a post by the user cyice on Stocktwits, who said: “when are the fundamentals of the stock ever going to take charge of its price“.

At $110 a share, Apple ($AAPL) is down around $20 or 16% from it’s highs just over $132. The stock trades at a PE ratio of 13. Minus the $200B in cash Apple has, that’s a PE of about 9. Meanwhile, companies like Google and Microsoft trade at PEs of 20 and 32 respectively.

I won’t go into why the market thinks Apple deserves a PE 1/2 of other tech companies (I wrote it up and decided to scratch it — the market is crazy and crazy hard to understand). If we just assume that the market has different rules for Apple, we can try to figure out what those rules are.

A chart…

aapl_5years

In July 2013, Apple traded at $60 with a PE around 10. It touched $130 this year and a PE around 15 and now trades at $110 with a PE around 13. Also notice how the price bounced off the 200 day moving average in July 2013.

So one answer to the “when are the fundamentals of the stock ever going to take charge of its price” would be around a 10 PE, which would correspond to a price of about $90 and also come close to that 200DMA. I’m long Apple in a retirement account and would back the truck up if it dips down around this area.

ZNGA Update and Options vs Common Stock

zynga_logo

Last week, I made the case to purchase Zynga stock in anticipation of their August 6th Q3 report. (BTW, you’ll be able to find the Q3 earnings report and conference call link on the Zynga Investor Relations site.) At the time, ZNGA was trading around $2.85 per share. Since then, the stock has dropped to around $2.60, recovering to around $2.70 at the time of writing this post.

My apologies to anyone who purchased on my recommendation last week and is now down about 5%. The thesis was to hold through earnings though, so hopefully you didn’t get scared out. It’s important to know both your exit from a trade and your tolerance for pain while holding through the trade. If you’re really following me, you are still holding. If you end up losing money after earnings, I apologize again, but I am not a financial adviser… this is not financial advice… please don’t sue… etc etc.

In my case, I’m bullish on Zynga as a company long term and looking to purchase as many shares as possible as cheaply as possible. I feel that $2.50 and definitely $2.00 are very strong support for the stock price and so barring any big screw ups in the company, it’s unlikely to go much lower than it is now. I think the current quarter’s earnings are likely to be good because the company has been turning around in general and also because their games have maintained high ranks in the app store “top grossing” charts while new games have come out. Existing games have had their video ad systems updated, and there is growth in general in both smartphone use and ads on smartphones. So things should be good. If they are, this might be my last chance to load up on Zynga stock before it starts to get expensive.

My Zynga holdings are about 8% of my retirement fund, which is on the mid to high side. I’m hesitant to add more, but I’ve also been hesitant to add more to other companies I had hunches about like this, and I’m trying to trust my gut more… especially when stocks are trading in value territory with lots of support. It would have been nice of me to have bought more Tesla, Amazon, and Activision at their recent lows. So I wouldn’t mind adding here even more before earnings.

Then the question becomes, what is the best way to add to my position? Should I buy more stock? Or purchase out of the money call options?

1. Just Buying Shares

This case is easy to analyze. I can buy about 300 shares at $2.7 each for a total of $810. If the stock moves to $3.10, I’ll make $0.40 on each share or $120. I’ll also have 300 shares in Zynga stock going forward. For my long term focused fund, it’s almost more important to track how many shares of a company you have (the assumption being you’ve picked great companies that will be valuable in the future) vs how much the stock price is up from your basis.

If earnings are poor or just not good enough and ZNGA shares trend lower, I’ll obviously lose X cents per share on 300 shares. Here is where things would stand at various price points:

$2.30: -$120
$2.60: -$30
$3: $90
$3.10: $120
$3.25: $165
$3.50: $240

2. Purchasing Call Options

When you consider buying options, things can get complicated. When purchasing stock, there’s basically two things you can do: purchase stock at the market price or wait. With options, you have to figure out not only when to buy but at which strike price and on which strike date. Here’s a view of the Zynga options chains in Etrade.

znga_options_2015-07-24

 

Figuring out which options to buy can be confusing and is the topic for another post (maybe there is one in our archive), but for now let’s assume I choose the options striking on August 7th (one day after the earnings call) at $3.00 (a good balance of risk reward).

Buying 140 contracts at $0.06, conveniently comes to $810. That would be $0.06 x 100 (100 options per contract) x 140 contracts. This purchase would give me the “option” to purchase 14000 shares of ZNGA stock at $3 per share. If the stock never gets to $3/share on August 7th, the options would expire worthless and I’d be out $810. If they got to $3.06 per share, I would just about break even. I’d be able to buy 14000 shares at $3 for $42k and then sell them at $3.06 for $42.8k. He’s what I would make or lose at different prices on August 7th:

$3 and below: -$810
$3.06: $0 (breakeven)
$3.07: $140 (about same as buying 300 shares)
$3.25: $3500
$3.50: $7000

As you can see the potential rewards are higher, but there is a bit more risk since I could lose all $810 invested. On the other hand, there is very little chance I would lose the total $810 invested in the “just buy stock” option. So let’s make a buy stock scenario that has a similar amount of risk.

3. Buying Shares with a Stop Loss

What is instead of buying 300 shares of ZNGA stock worth $810, we bought a higher number of shares and used a stop loss to limit our downside risk to $810. What might this look like? The first step would be to figure out a good place for that stop loss. Recently ZNGA got down to $2.60, but didn’t go lower. The current 200 day moving average is also hovering right around that number providing support. There is support at $2.60, so let’s place our stop loss there… 10 cents below the current $2.70 price.

If we bought 8100 shares at $2.70, we could set a stop loss at $2.60. Assuming no slippage (i.e. our stop loss actually fires at $2.60 when the stock gets that low), we would only lose $810 on those shares if the stock price went lower. Here’s what we would earn at the same price levels as in the options scenario:

$2.60: -$810
$3: $2430
$3.06: $2916
$3.07: $2997
$3.25: $4455
$3.50: $6480

In this scenario, we would risk the same $810, but stand to make even more than purchasing $3 options would. In some ways there is less risk in this scenario, since we still make money (a lot actually) if the stock doesn’t trade above $3. We also have the option of holding the shares past August 7th if we want to.

In some other ways, there is a lot more risk though. If ZNGA is trading at $2.65 before earnings, then reports terrible earnings and opens the next day at $2.30. There is a chance my stop loss would sell below my target and we could lose something like $3000 or more selling those shares for a loss. Oops.

The other thing to note in this scenario is that you would need to come up with $21.8k to purchase those shares, which is more than my current holdings. One option would be to go on margin to get that money. Generally, that’s a bad thing to do without knowing what you are doing. Purchasing options is actually one way to effectively trade on margin, but with fixed costs.

What am I going to Do?

I’m not sure yet. The options option looks nice as a way to gamble an extra $810 on this next earnings with a fixed amount of downside risk. Buying shares could be good as well, but I would do something between Option #1 and #3 above. For example, instead of buying them all at once, I could buy 3000 or so and then buy 3000 more if earnings were bad (and I still believed in the company). I’d have lost money, but would have even more invested in the company ready for the turn around. This is basically the strategy of my portfolio. It’s worked well for me with Netflix, Tesla, Activision, and currently Nintendo. Of course, I could get unlucky and average down on a company like this that drops to $0. The idea is I would hopefully make up for it with my winners… or basically be able to make good judgements to cut my losses when I really need to.

If I figure out what I’m going to do. I’ll post an update. Good luck everyone!

The Long Case for Zynga $ZNGA

ea_hero_imageAside: I’m going to try to blog here when I do research for stocks I’m investing in and in particular when I am sharing ideas with my mother. Explaining an investment to my mother and to the blog here are remarkably similar processes… so two birds with one stone and all.

Next up: Zynga (ZNGA).

Zynga makes games for mobile phones and tablets and also for sites like Facebook. They famously made their fortunes on the back of games like Farmville and Mafia Wars before going public. Since then, they have done a number of acquisitions and spent a bunch of money, but generally failed to create hits as big as Farmville was at the time. Their stock has tanked from $10/share at IPO to ~$2.85/share right now.

Sounds glum, so why am I bullish now? I’ll try to bullet point the case here, dive into some of the numbers, and then post the risks.

The Case

1. Downside is limited by cash and assets.

At $2.85, Zynga’s market cap is about $2.62 Billion. In 2014, they had about $1.8 B in shareholder equity, including about $1B in cash and equivalents and a $300m office. This puts a floor of about $2/share on the stock, with technical support at $2.50.

2. Revenue is turning around.

Revenue numbers were up year over year the past 3 quarters. Zynga is already set to post their first annual YoY gain in revenue since the IPO and a surprise this quarter topping $175m (which is above most estimates) would mean 4 quarters in a row of YoY revenue growth.

It appears that Zynga is turning the corner on revenues, and while up from all time lows, the stock price still seems to reflect a company that is shrinking and not growing.

3. Mobile games industry is still growing.

By one account, the mobile games market grew from $21.7B to $25 from 2013 to 2014. That 15% per year growth is going to be a nice tailwind for the mobile games market. So even though Zynga is not the only game in town, the pie is getting bigger.

Many traders are watching the iOS and Android store “top grossing” charts and trading parent companies as games move up and down the list. The position of games on this list is a great indicator of revenues for the parent companies, but it seems people are being harsh as games move down the list. A top 10 spot on the list today is worth as much as the top 1 spot a few years ago. And so Zynga with 2 top 20 games in Hit it Rich and Wizard of Oz Slots is making decent revenue despite sliding down the list a bit.

4. Games pipeline is strong.

Zynga released Empires and Allies this quarter, which has done well on the charts. It’s recently jumped up the free downloads chart (as high as #1) while simultaneously sliding down the grossing charts. This is really odd, and some have accused Zynga of manipulating the free downloads charts. There have been bugs forcing people to reinstalls (probably not adding bugs on purpose) and Zynga has been advertising Empires and Allies on Twitter and other places, both of which would inflate download numbers.

Historically, Zynga has done much advertising promotion for their games. Instead they relied on their social integration to get gamers to bug their Facebook friends for virtual wood to build their farms. In my opinion, the fact that Zynga is starting to advertise Empires and Allies is more a sign that they believe they have a good pipeline to convert ads into real customers than a sign of desperation to inflate unimportant numbers.

Besides Empires and Allies, Zynga will be releasing a couple games from Natural Motion which they acquired last year: CSR2 Mobile Racing and Dawn of Titans. Both games are visually heads and shoulders above other mobile games and could be very popular as customers look for something to take advantage of the beefier tablets coming out.

5. Ad revenue should increase.

There is more demand for ads on mobile devices and game developers are getting better at integrating ads into their games in ways that are not intrusive and actually encourage users to watch video ads. In particular, users can watch video ads in Zynga slot games to earn money to spend on the slots. Similar features are being added to exiting Zynga games and will surely be included in all future games.

Ad revenues are not incorporated into iOS and Android “Top Grossing” and so can be missed by traders and investors focusing on those numbers.

Higher revenue from smarter ads means that Zynga can earn higher revenue even with lower daily active users.

6. Real Money Gaming could be huge.

Real money gaming hasn’t taken off on mobile yet, but as regulations loosen up or companies get bolder things could start moving fast. Gambling via fantasy sports is a booming industry, which is an indicator of demand for fantasy sports but also for gambling.

Zynga is in a good position here with top casino games, the top free poker game, and lots of real money gaming patents.

Future Stock Price Estimates

The general thesis here is that revenues are turning around, existing cash cows and cash chickens will support current levels of revenue while new games and eventually real money games will support growth in revenue.

If Zynga can grow back to $1.2B/year in revenue and and make $360m/year on 30% gross margins, their stock price could be:

  • $4.02 based on 2x revenue + cash value ($3.7B Market Cap).
  • $6.03 based on 15 PE ($5.55B Market Cap)

Again, this would be based on the assumption that Zynga can double revenues and achieve a decent profit margin. Considering they’ve hit these revenue numbers before, it’s not unreasonable to think a more mature Zynga might “get lucky” again.

It took Zynga 3 years to shrink from $1.2B/year revenue to $680m/year. If it takes 3 years to grow back to that level, the estimates prices above would represent total gains of 40% and 111% respectively, or annualized returns of 12% and 28% respectively.

 

Still, there are risks…

Risks

The main risk to this thesis is that existing Zynga games drop off in users and revenue while new games coming out fail to gain users.

Also there isn’t a great explanation why Empires and Allies can have so many downloads without a similarly high placement on the top grossing lists. It could be that Zynga is wasting money advertising Empires and Allies without a proper return.

If the turn around in Zynga’s revenue is not accompanied by a turn around in earnings this year, then they will continue to lose cash pushing the $2 price floor lower.

Summary

I have a position in Zynga shares averaged around $2.90 a share and added an amount equal to 50% of my old position recently in anticipation of Zynga beating Q2 revenue and earnings estimates in their August 8th earnings call.

If the earnings goes well, Zynga should climb to $3.50 or higher. If not, there could be a pull back with technical support at $2.50 and fundamental support at $2.00.

Bitcoin hits $1000. Where is it going?

I’m bullish on Bitcoins, from a price perspective and also from a technology perspective.

Like many out there, I’m kicking myself for not jumping on the bandwagon sooner. I remember when they were $5 and I was first reading about them. I remember when they were less than $1 per coin, and my office computer could mine about 1 per week, thinking it wasn’t worth the electricity cost. I remember wanting to buy 200 of them at $10 each as a speculation play with our InvestorGeeks ad money, and then wanting to use my own money.

At those times, buying Bitcoins was harder to do and more confusing. I kept putting it off. Now, services like Coinbase are making it pretty easy to buy and sell them. FWIW, I now own about 8 of them personally purchased from $65-$350 each.

I just replied to a post on Howard Lindzon’s blog with some of my thoughts RE why Bitcoin is the perfect vehicle for speculators and why good or bad the price is likely to go up. I may post more about Bitcoins here from time to time along with other investing writing.

Bitcoin is really useful is so many ways and the technology is just getting started. But the asset is just perfect for speculation. It’s designed to have 0 inflation, which means it has basically infinite deflation. It trades 24/7. And there is no real way to value a Bitcoin. So unlike cerca-2000 internet stocks, where you can say “hey this company isn’t actually making any money”, with Bitcoin there is no “main street” valuation to add any sense into the price levels.

FWIW, my favorite valuation method is to compare the total amount of transaction activity to the GDP of US states or small countries. So if people do as much commerce using Bitcoins as is done in the state of Pennsylvania in USD, that would be about $400B per year or a $400B “market cap” for Bitcoin, which is about $20,000 per coin. Of course that makes hardly any sense, especially when a lot of the Bitcoin transaction volume is investing and moving money around in accounts. But that’s kind of the point. We have no f’ing clue how to figure out what the value of a Bitcoin is.

The 1% is sitting on a lot of money and as they put some of that into Bitcoins, the price is going to go up. It has some room to run IMO. As more companies, investors, and people in general get skin in the game, there will be a limit to how far prices can crash. Lots of people have a stake in making sure Bitcoin doesn’t become “worthless”.

Of course some more experienced investors who were paying close attention to other “bubbles” in the past probably recognize this as a case where smart/wealthy speculators are taking advantage of other dumb/wealthy and not-so-wealthy speculators.

So the speculation that is a large part of the current price level is going to stick around. I find it hard to believe that with increased use and spending of Bitcoins (public ATMs, everyone with a Bitcoin debit card, Bitcoin transactions baked into internet ecommerce) that the speculation will die down.

We have a few more waves left in this IMO. That log chart is probably a good way to try to time it, but be careful.

Looks like a buying opportunity in BBBY

My Mom asked me about Bed Bath and Beyond recently. She used to be a store manager there. She sold her stock a while ago (missed that big up swing) but thinks there may be a buying opportunity now. I also owned some way back and sold after a small gain, missing most of the big 2-3 year rally here.

Anyway, here is my analysis and response to her. (The spreadsheet I refer to is one based on Phil Town’s Payback Time book you should be able to find on his tools page here.)

BBBY looks like a good buy. They are in sound financial shape. I’ll save you the math, but here are some numbers. You can dig them out of the attached spreadsheet as well.

Earnings Per Share: 4.291
Earnings Growth Rate: 15% (Past 3 years has been 21%, analysts expect about 14-15% going forward. I usually take the lower of these.)
Average PE: 15
Min Acceptable Rate of Return: 15% (what we hope to make on our investments)
Margin of Safety: 50% (We want to buy $1 worth of a company for $0.50 just to be safe.)

Based on the above, the “sticker price” for BBBY is $64.37. That means, this is the true value of the company if you expect all of the numbers above to go on for the next 5-10 years (e.g. keep growing at 15%) and have a rational market. (FWIW Trefis has BBBY valued at $74.77. That’s the price they’ll show in Etrade in the research.)

The MOS price (we want to get a bargin) is $32.18. This is the “it’s dumb NOT to buy this company at this price” price. If you change the MOS from 50% to 25%, which you can do if you feel you have extra knowledge about the company to lower the risk of something surprising happening against you, the MOS price become ~$48.

So based on my #s the company is slightly undervalued (by about 20%) at $55.

Here’s a 3 year chart to see what’s happened lately.

So there was a nice uptrend channel for the past 2-3 years that has been broken toward the downside. This is a stock in recovery mode. The next level of support is at $50. Based on the chart, this stock will very very likely hit $50. If that supports well, it should develop from there into a new uptrend. With new resistance at $60, and the former trend line resistance back at $75-80.

So things to think about: The trade here isn’t to buy and wait for it to go up and sell higher. That’s what you do when the stock is within the channel like it was for the past few years. Now you accumulate stock as cheaply as possible and wait for things to turn around to sell. I guess another way to put it is that this chart tells you more about when to buy vs. when to sell.

I would buy no more than a 25% position now. Buy 25% more if/when it hits $50, and then if it drops below $50, buy at $40ish and $35ish. At that level, unless the company is about to go out of business the stock price will be a bargain and turn around eventually. (Kind of like the ZNGA at $2 buy and the NFLX at $60 buys.)

If it stabilizes at $50, then you can play that other 50% once it defines a new uptrend.

The one thing I didn’t talk about here is any news about the company. I haven’t heard anything and didn’t search the news while looking this stuff up. Did anything big happen to BBBY besides missing earnings this past quarter?

I may buy some of this too. I’ll let you know what I do.

Would I Buy Netflix in the $50s?

Netflix lowered their subscriber numbers for the year last night, leading to a big 14% drop in the stock price today (so far). Fellow InvestorGeek Chris texted me asking if I’d be buying Netflix in the 50s.

I personally won’t be buying any $NFLX stock today, but only because I already own a lot of Netflix stock int he $60s. I have too much tied up in $NFLX already to add to my position. Though I may buy in more later this year, early next, as I fund my account and if $NFLX drops lower.

I believe in Netflix long term, and am building up a position with the intention to hold at least through the current international expansion and the implementation of their original content (Arrested Development, House of Cards).

Buying now is not a no-brainer. But could be an opportunity if you think long term.

Think Long Term with Netflix

Any investor in Netflix now has to be ready to hold for at least a couple of years. The current market is very focused on earnings right now (excluding Amazon investors for some reason), and Netflix won’t have earnings for a while as they reinvest them into international expansion and content expansion.

The play here is that once Netflix stops spending money on expansion, they’ll be able to keep a large portion of that $7.99 per subscriber per month they are getting. Why not?

That said, $NFLX stock has tended to swing fairly predictably after these big moves. So I think a quick trade once this current action bottoms out could result in a nice 10% gain. But the current trend is down. Don’t trade against that unless you are tuned in.

Subscribers

Chris asks me if I think the “bleeding” of subscribers has stabilized. The answer is yes. All of the subscribers who were going to leave because of the price increase seem to have left already. Netflix is losing DVD subscribers, but that is expected, and new streaming subscribers are offsetting those losses.

Some subscribers may be leaving because of the lack of content. Or to switch to a competing service. But these don’t seem like huge structural issues to me… really just part of normal turn over for a service with competition. Netflix is the best video streaming service and will be for some time to come.

Which brings me to the two main things to worry about with Netflix: (1) competition, and (2) cost of content.

Worry #1: Competition

I’m not as worried as many about Amazon and other competitors in the space. Netflix did well against Blockbuster back in the day. Many underestimate the cost of building the infrastructure to become the largest source of traffic on the internet. Really only Amazon has the chops to replicate this. But then Amazon has some other problems.

Amazon is way behind in terms of devices for their service. By the time they catch up, Netflix will be on your car and in your Google Glasses. Amazon is also behind in terms of recommendation technology. This, coupled with the fact that Netflix knows my past viewing history, means that Netflix is going to be a better browsing experience for me.

And last, but not least, Amazon will always have a schizophrenic business model for video since they want to stream free movies alongside movies you have to pay for. There is a place for this, but it means that Netflix will always stand out as a nice easy way to find something to watch. There is no incentive for Amazon to switch to all free streaming when they make billions more already from selling actual videos.

Worry #2: Content Costs

On the content cost side of things, some are worried about the “off-balance-sheet debt” that Netflix has. Some information here and here. In more laymen terms, Netflix has contracts worth billions of dollars with content providers that go out over several years. These costs don’t make it onto the balance sheet as debt (or payments owed) because the accounting only shows what is due the current year. Some believe that Netflix has been manipulating these contracts so the payments are due later, and expect a large increase in these costs soon that Netflix won’t be able to cover with revenue.

It’s possible some shenanigans are going on here. Personally, I have some trust in Netflix management and see this as a reasonable way to do accounting for contracts that go into the future. On the extreme side, if Netflix signed a 30 year contract to pay $200m to a content provider, you wouldn’t expect them to consider that $6B worth of costs right now. It makes sense to spread that out over the years the content is being streamed.

Outside of the off-balance-sheet debt, some worry that content providers will charge more for content or even collude to choose a winner in the space (maybe Hulu, which is owned by NBC, Fox, and Disney). It’s possible, but I already see signs that Netflix has gotten large enough to enforce some leverage of its own in these negotiations. So while Netflix lost out on Starz’s content. Starz lost out on as much as $200m per year. Other Networks would have similar pay checks to lose. As Netflix grows, they’ll become a larger source of revenue for the content providers.

In Summary

I don’t want to make it sound like the concerns of investors right now are minimal. They aren’t. Netflix faces some big challenges ahead of it. However, if you believe in the company’s ability to navigate these challenges, there is a huge payoff for what may become a huge business.

For a sense of the potential here, Netflix currently has 25m subscribers. They will make about $3b/year revenue off these subscribers. The top 20 countries together have over 400m broadband users. As broadband penetration grows and Netflix’s international reach grows, can they grow to 50m subscribers? 100m?

At current prices, you can get $NFLX stock at less than 1x revenue. For a company that is growing, this is a steal. There are real concerns with competition and content costs, but many under estimate the technical and competitive advantage Netflix has as the early leader in streaming, which is currently the largest streaming service in the world.

Again, buying in at current prices is NOT a no-brainer. For those who think Netflix will be a big player in streaming 5 years from now, yeah. Buy on the dips.

NFLX (Netflix) Technical Analysis

Netflix is another company I’m accumulating stock in for a long term play. Until recently, NFLX was one of those stocks I always wanted to buy into but thought it was overpriced. I waited for a pull back that never came until… all the hoop la last fall.

Assuming subscribers and revenue can grow faster than content costs (not a sure assumption, see SIRI as a counter example), Netflix is going to make some good money and is worth more than 2x Revenue IMO. Buyout possibilities are the icing on the cake here.

Here’s the 6 month chart. You see some support around $105. (NFLX fell through that after writing this up, let’s see if that old support becomes resistance.) The next important level is around $90. I have a large (for my account) number of shares already bought during the big drop last year. However, if I get the funds, I would consider adding to my position at that level with the understanding that the stock could go lower.

If you are buying for a short term trade, watch that upper line of the channel above that’s around $120 right now.

Here’s the 3 year chart showing the sell of from last year. That down trend is over. The uptrend we’re in is not clearly defined yet.

Buying when the stock was in the $60-70 range was a good move for the short term here. (Hindsight, Duh!) I’ll be watching to see how NFLX responds to that support line I drew up there. With all of the PR mishaps of the last few years, and lots of oversees and content investments being made by the company, there are lots of short term risk in this stock. I would not be surprised if the stock plays with that $60 level again sometime this year. If so, I’m buying.

Be careful buying this stock. As for selling. For a short term play, that 200 day/week moving average above at around $150 would be a good short term target. Because the stock fell so fast, there isn’t a lot of resistance above that. The stock likely goes up to $200 to $300 again if and when things turn around for the company. So it might be good to let some ride if the stock does start moving up above $150 again.

MSFT (Microsoft) Technical Analysis

I bought a chunk of Microsoft (MSFT) stock at $25. At the time, my thinking was “why does MSFT have a PE below 10”? While a stock like AAPL is priced for perfection (which they keep delivering), at a 10 PE Microsoft was priced for mediocrity… and it’s been treading water it has for the better part of a decade.

We’re now moving toward that $35 level where it’s had trouble in the past. All MSFT needs is a break out product to bust through that level and reach toward its former glory at the $40 and $50 levels.

But don’t get me wrong, I know what company we’re talking about here. Microsoft hasn’t been able to succeed Apple-style with any of their recent products launching in new categories. The stock has been bouncing between $25 and $35 for a while. Short something miraculous happening for the company, I’m looking for queues to sell.

 

Above is a six month chart. You can see how the top trend there has been broken. The stock is holding up at the 50-day moving average which lines up with that second trend line I drew. Support exists at $30, $28.50, and the 200-day MA at around $27.50.

The long term picture. If MSFT holds up above $30, look for it to test that $35 range again. If it drops below $30, look for it to trade back down to $25-ish level.

Update: I put a stop in at $30.97 and had my stake sell out the other day.