The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [192]
Two things jump out from Hoffman’s answer:
Since Commerce One was already losing $2 on every dollar in sales, if it quadrupled its revenues (as “analysts expect”), wouldn’t it lose money even more massively?
How could Commerce One have exceeded expectations “in the past”? What past?
Asked whether his company would ever turn a profit, Hoffman was ready: “There is no question we can turn this into a profitable business. We plan on becoming profitable in the fourth quarter of 2001, a year analysts see us making over $250 million in revenues.”
There come those analysts again! “I like Commerce One at these levels because it’s growing faster than Ariba [a close competitor whose stock was also trading at around 400 times revenues],” said Jeanette Sing, an analyst at the Wasserstein Perella investment bank. “If these growth rates continue, Commerce One will be trading at 60 to 70 times sales in 2001.” (In other words, I can name a stock that’s more overpriced than Commerce One, so Commerce One is cheap.)7
At the other extreme was Capital One Financial Corp., an issuer of MasterCard and Visa credit cards. From July 1999, to May 2000, its stock lost 21.5%. Yet Capital One had $12 billion in total assets and earned $363 million in 1999, up 32% from the year before. With a market value of about $7.3 billion, the stock sold at 20 times Capital One’s net earnings. All might not be well at Capital One—the company had barely raised its reserves for loans that might go bad, even though default rates tend to jump in a recession—but its stock price reflected at least some risk of potential trouble.
What happened next? In 2001, Commerce One generated $409 million in revenues. Unfortunately, it ran a net loss of $2.6 billion—or $10.30 of red ink per share—on those revenues. Capital One, on the other hand, earned nearly $2 billion in net income in 2000 through 2002. Its stock lost 38% in those three years—no worse than the stock market as a whole. Commerce One, however, lost 99.7% of its value.8
Instead of listening to Hoffman and his lapdog analysts, traders should have heeded the honest warning in Commerce One’s annual report for 1999: “We have never been profitable. We expect to incur net losses for the foreseeable future and we may never be profitable.”
Pair 4: Palm and 3COM
On March 2, 2000, the data-networking company 3Com Corp. sold 5% of its Palm, Inc. subsidiary to the public. The remaining 95% of Palm’s stock would be spun off to 3Com’s shareholders in the next few months; for each share of 3Com they held, investors would receive 1.525 shares of Palm.
So there were two ways you could get 100 shares of Palm: By trying to elbow your way into the IPO, or by buying 66 shares of 3Com and waiting until the parent company distributed the rest of the Palm stock. Getting one-and-a-half shares of Palm for each 3Com share, you’d end up with 100 shares of the new company—and you’d still have 66 shares of 3Com.
But who wanted to wait a few months? While 3Com was struggling against giant rivals like Cisco, Palm was a leader in the hot “space” of handheld digital organizers. So Palm’s stock shot up from its offering price of $38 to close at $95.06, a 150% first-day return. That valued Palm at more than 1,350 times its earnings over the previous 12 months.
That same day, 3Com’s share price dropped from $104.13 to $81.81. Where should 3Com have closed that day, given the price of Palm? The arithmetic is easy:
each 3Com share was entitled to receive 1.525 shares of Palm
each share of Palm closed at $95.06
1.525 $95.06 = $144.97
That’s what