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The Growing Potential Of 3D Bioprinting January 29, 2013

Posted by Ishmael Chibvuri in Latest Articles!!!.
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Organovo Holdings (ONVO.PK), a creator and manufacturer of three-dimensional human tissue for medical research and therapeutic applications, is working together with researchers at Autodesk (ADSK), a maker of cloud-based design and engineering software, to create the first 3D design software for bioprinting.

The software will be used in conjunction with Organovo’s NovoGen MMX bioprinter, and represents an important step in improving usability and functionality for the design of 3D human tissues with the potential to extend the population of bioprinting users. Organovo’s 3D bioprinting technology can create living human tissue that is three-dimensional, correct architecturally and composed of living human cells. The tissue can function like native human tissue, and this represents an opportunity for advanced drug discovery and development, and potential surgical therapies and transplants in the future. Autodesk is focused on developing state of the art technology for human-computer interaction, computer graphics and digital design. The bio/nano/programmable matter group is extending this expertise to develop software for the design and simulation of molecules and living systems.

Below, I will explain what 3D bioprinting is, the synergies between Organovo and Autodesk, the potential of 3D bioprinting, and the growing demand for human tissue including organs.

What Is 3D Bioprinting?

Organovo is developing ways to print living human tissue with the objective of producing body parts and implants in a process known as computerized adaptive manufacturing. Custom prototypes and finished parts are produced with the use of affordable 3D computer printers. Instead of extruding plastic, metal or ceramics, these medical printers extrude an ink of living cells. This is called shorthand bioprinting. This is a new use for a standard technology that we are all familiar with in the use of conventional inkjet printers. The printers can create tissue structures, layer by layer, in any 3D shapes, such as tubes, patches of skin and muscle to be used as living Band-Aids.

The Synergy Between Organovo and Autodesk

This is a partnership with a lot of potential. Organovo’s NovoGen MMX Bioprinter is a novel, fully automated (custom graphic user interface), hardware and software platform developed specifically to meet the requirements of biological research and bioprinting. From a hardware point of view, it is an extremely powerful tool using state of the art technology, however, it runs on software that is not anywhere near as up to date. Every time a scientist wants to use the printer, the code has to be written from scratch, and this means that the scientist is preoccupied with debugging code instead of advancing research.

Autodesk, the CAD software leader, has become prominent in many professional areas of design, ranging from architecture to industrial design. Virtually anything that has been built in the last two decades may have been designed using Autodesk software, but this is the first time that the company will be working on software that creates living things. The first applications will likely be simple tissues that could be ready for clinical trials in the next five years. Meanwhile, Organovo intends to generate a steady and sustainable revenue stream by producing tissue to be used in drug research, discovery and development.

The Potential Of 3D Bioprinting Technology

The best way to get some idea of the potential of 3-D bioprinting technology is to look at the evolution of other technology that would have been unthinkable even two decades ago. Though the technology is different, the most compelling recent example is the development of tablets and smartphones. What made the leap forward possible was the ability to provide consumers with a multifunctional hand held device that was useful and portable at an affordable price. It was Microsoft (MSFT)which first introduced the Microsoft Tablet PC, the first commercially available tablet in 2002, which was not as successful as had been hoped. It took another eight years before Apple (AAPL) would break technological barriers with the introduction of the iPad in 2010. Today, tablets are selling in the millions and soon expected to overtake laptops and notebooks.

The development of 3D printing has recently become one of the hottest new technologies. 3D printing started as far back as 1984. It took the prevalence of Moore’s Law to advance the technology while reducing costs to the point where it made business sense for mainstream companies to utilize 3-D printers. As a result, the market leaders in the 3D printing field, 3D Systems (DDD) and Stratasys (SSYS), have been two of the hottest companies over the last two years. 3-D printing companies have been soaring recently. According to CNN Money, 3D printers were expected to be all the rage at the recent CES gadget trade show in Las Vegas in early January. 3D Systems has already jumped 15% since the beginning of 2013, after seeing a stellar performance in 2012.

The 3D printing industry is expected to see high growth and revenue generation in the near future as more and more companies begin to adopt the technology. Today, giant companies such as Ford (F), Boeing (BA)and GE (GE) are already utilizing 3D printing in their manufacturing operations. According to Brian Mathews, vice-president of Autodesk, "3D printing is a way to re-envision the manufacturing process." Ford uses 3D printing for speed and cost effectiveness in prototyping. Similarly, Boeing has used 3D printing for parts on military aircraft. In November 2012, GE bought privately-owned Morris Technologies, an engineering firm that has heavily invested in 3D printing equipment. The company will be focusing on printing bits for a new range of jet engines.

It is not difficult to see how 3D bioprinting of human tissue including organs could follow the same growth trajectory.

The Demand For 3D Bioprinting Technology

According to Donate Life America, a U.S. based not-for-profit alliance working toward increasing organ, eye and tissue donation, "Although there have been advances in medical technology and donation, the demand for organ, eye and tissue donation still vastly exceeds the number of donors. The organization also says that "more than 115,000 men, women and children are currently awaiting organ transplants in the United States."

CompaniesandMarkets.com is a global aggregator of business information staffed by expert analysts who have authored hundreds of market research reports. According to expert contributor Mike King,

The global artificial organs market is forecast to reach $20 billion by the year 2017, primarily driven by the growing demand among patients for organ transplants. Additionally, technological advancements, cost benefits, an aging population, and scarcity of donor organs are some of the other factors which are expected to fuel demand within the artificial organs market in the upcoming years.

The report also said that artificial pancreas is expected to witness lucrative growth prospects due to 100 million people across the world suffering from diabetes mellitus. Worldwide demand for artificial organs is led by artificial kidneys.

Conclusion

There are other companies working in the field of tissue regeneration and treatment such as Tengion (TNGN), but they are using more conventional technology instead of bioprinting, and none of them have the same focus as Organovo. It could take a long time to profit from the potential of 3D bioprinting and, despite the considerable investment risk, the potential returns could be astronomical.

However, there are favorable short-term price catalysts from the efforts to generate revenues from drug discovery and development. In 2010, Organovo struck a partnership with Pfizer (PFE), under which the company was to earn $450,000 in revenue through the end of 2012. The company has a second agreement with United Therapeutics (UTHR), concluded in October 2011 for a period of 30 months, under which Organovo is utilizing its bioprinting technology to conduct research on treatments for pulmonary hypertension. Organovo has recognized $618,000 in revenues from this deal.

Investors looking at the biotech sector should perform further research on Organovo Holdings to see if it fits within their investment portfolio.

Source: http://seekingalpha.com/article/1135651-the-growing-potential-of-3d-bioprinting?source=email_investing_ideas&ifp=0

The Life Insurance Industry Is Ripe For The Picking January 29, 2013

Posted by Ishmael Chibvuri in Latest Articles!!!.
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Disclosure:I am long AIG, AFL, LNC. (More…)

Sometimes when you analyze companies you start to find good to great companies all in a particular industry that are cheaply priced. You have to ask yourself why a particular industry as a whole is underperforming as was the case with home builders since 2007. Sometimes an industry underperforms for valid reasons and sometimes the reasons are not valid enough to drag down great companies.

In 2007, the home building market went south and for good reason. The mortgage debacle and great recession all acted to bring down an industry (several industries) and even the US to its proverbial knees. Now the reason behind the rapid decline in the fortunes of home builders was justified. No one was buying and mortgages were all but impossible to get as banks closed the mortgage lending spigot. The mortgage mess and resulting home market crash were products of poor lending standards.

Sometimes industries like the life insurance industry get crushed for short-term reasons. Right now the headwinds on the life insurance segment are coming from the low interest rate environment which impedes a life insurance company’s earnings on its float. Most life insurance companies collect fees for life insurance for years before they ever have to pay a claim. They use these huge sums of cash called the float to invest before claims are paid and usually they choose ultra-safe investments for the float. As most people are aware safe investments like T-bills and other government backed securities are paying historically low rate of return because the Federal Reserve has kept interest rates artificially low for the past several years. This hurts an insurance company’s earnings and squeezes the return on the float.

The life insurance industry sales were somewhat subdued in 2012 and the number of new policies sold, as a whole, has been fairly flat for the past five years. The industry as a whole has seen stagnant, but steady since 2009. The life insurance industry should see increasing sales as the economy improves and the unemployment rate drops. As 2013 progresses the life insurance industry will continue to face limited investment income due to low interest rates and a flat yield curve. One bright point is that variable annuity sales have been setting records sales numbers at many life insurance companies.

Largest Life Insurers, by Individual Net Life Insurance Premiums, 2011 (thousands)

Northwestern Mutual $11,449,223

MetLife, Inc. (MET) 10,543,808

New York Life 7,960,177

Swiss Re America (SSREF.OB)6,320,565

Prudential Financial (PRU) 4,195,957

Lincoln Financial (LNC) 4,131,369

Massachusetts Mutual 4,069,532

State Farm 3,945,058

AFLAC (AFL) 3,585,564

Guardian 3,215,759

AXA Financial (AXA) 3,083,974

Protective Life (PL) 2,699,098

Berkshire Hathaway (BRK.B) 2,397,813

American International Group (AIG) 2,392,441

Manulife Financial (MFC) 2,135,712

RGA Group (RGA) 1,742,265

Pacific Life 1,633,939

Hartford Life, Inc. (HIG) 1,603,635

Thrivent Financial For Lutherans 1,526,933

Allstate (ALL) 1,506,942

Principal Financial (PFG) 1,339,044

Torchmark (TMK) 1,215,993

Source: ACLI tabulations of National Association of Insurance Commissioners (NAIC) data.

The reason I’m bullish on life insurance companies are the great values found at many companies. Many life insurers have very low relative P/E ratios, very decent dividend yields, steadily growing earnings, and many life insurers have fantastic book/price valuations. In addition, many life insurers are strengthening their balance sheets and capital positions while also reducing debt. So you have an undervalued industry that is ripe to strengthen in the future and the main way to unlock the value in these companies is with an increasing interest rate environment. Given that interest rates are being kept artificially low by the Federal Reserve you have a situation that can’t last and interest rates will start to rise. My expectation is that interest rates will start to rise in the second half of 2013.

(click to enlarge)

The key is to identify industries like these while they are down and choose the most promising companies while valuations are low. Now is the time to purchase ownership in this industry. The industry from a macro level is looking undervalued. What really matters through is each company at the micro level and which companies in the industry will outperform over time as the industry rebounds.

And The Winners Are

The best insurance companies for investment consideration are:

1. Aegon- (AEG)

2. Aflac- (AFL)

3. American International Group- (AIG)

4. Lincoln National- (LNC)

5. Manulife- (MFC)

6. Prudential- (PRU)

Aegon

Aegon is a large diversified life insurer located in the Netherlands with a market cap of $12.5 billion. About 90% of their revenue comes from their US and Netherlands operations. Aegon has a P/E ratio of just 8.4% and a dividend of 4%. The company is selling at about 30% of its current book value. It’s rare to see a growing company selling for such a low price/book valuation. I see Aegon climbing in value this year to a more reasonable book valuation. Aegon needs a European turnaround and an increase in interest rates to start climbing higher.

Aflac

Aflac had a solid year in 2012 and is preparing to move higher. Aflac has started a new investment program that is allowing to safely earn about 70 basis points more interest on its float. Earnings are increasing at around 12% per year. Aflac is expected to continue to grow due to an aging Japanese population and a growing presence in the US.

The numbers look good on Aflac. Aflac sports a P/E of 9 and generates a 3% dividend yield. Aflac is also selling at a 45% discount to its fair market value. I calculated it value using a discounted cash flow analysis using a 12% future growth rate for the next 5 years and current earnings of $5.80/share.

AIG

AIG is moving in the right direction by shedding assets to lower its debt and by the government selling off the last of its interest in AIG. AIG posted a $6.5 billion profit for 2012 vs. a $1.5 billion profit in 2011. A reinstated dividend appears to be in the cards for 2013 or 2014. AIG’s book value is $71/share vs. its current price of $30/share. AIG is selling at about a 37% discount to its fair market value. The biggest drawback to AIG is its $73 billion debt level.

I know many people still have their doubts about AIG. I think the worst is behind the company. They have faced their worst secrets and have rebounded. The underlying business that AIG still owns is a healthy and robust business. The skeletons are all out of the closet and AIG is now poised to grow.

Lincoln National

Lincoln National is growing earnings at about 7.5% per year and it has a 2% dividend. Lincoln National’s P/E ratio is a low 5.8% and it sells at a 49% discount to its fair market value. Lincoln National has risen about 20% from when I recommended the company in November 2012. The company is still selling at a 50% discount to book value and I predict that the company has room to still dramatically increase in price. My prediction is that Lincoln National will double in value by 2014.

Manulife

Manulife is Canada’s largest life insurance company and it appears to be doing very well. Manulife is making a major push to into Asia and business from that region is growing at a much faster rate than in Canada or the US. Manulife is at par with its book value and its debt matches its market capitalization. The company has a 4.8% yield and earnings look to double in the next 2-3 years. With a P/E ratio of 9.5% Manulife looks to have a bright few years ahead of it.

Prudential

Prudential has a low 7.6% P/E ratio and a rising 3.3% dividend yield. As with most life insurers Prudential is selling for just slightly above 50% of its book value. I expect earnings to grow at a modest but steady 9% over the next 5 years. Prudential is growing its business through both internal growth and through smart acquisitions.

One risk with Prudential is that it has been notified by the government that it may be designated as a systematically important non-bank financial institution (SIFI). This would mean more oversight by the US government. This could weigh on Prudential’s performance, but I still believe that the company will produce solid returns and is cheaply priced.

Company Ticker Price PE Dividend Div DCF Percent Growth Rate Earnings Book Return
Yield Value DCF Rate-past 5 years Value on Equity
Principal PFG $26.00 9 $0.72 2.70% $42.00 38% 6% $3.00 $36.00 9%
Hartford HIG $17.00 5.6 $0.40 2.30% $51.00 67% 10% $3.05 $55.00 6%
Aegon AEG $4.68 6.2 $0.13 2.80% $7.40 37% 2% $0.75 $14.75 5%
Lincoln National LNC $25.90 5.3 $0.32 1.80% $51.00 49% 8% $4.05 $52.85 9%
Manulife MFC $10.92 9.9 $0.52 4.80% $14.34 24% 9% $1.10 $15.10 10%
Prudential PRU $53.30 7.4 $1.65 3.40% $85.39 38% 9% $6.55 $90.90 7%
Aflac AFL $53.00 9 $1.34 2.90% $97.00 45% 11% $5.80 $32.00 18%
AIG AIG $31.00 9 $0.00 0.00% $49.00 37% 10% $4.40 $71.00 6%
Unum UNM $20.82 6.5 $0.47 2.50% $42.00 50% 10% $3.10 $31.65 10%

Source: http://seekingalpha.com/article/1136621-the-life-insurance-industry-is-ripe-for-the-picking?source=email_investing_ideas&ifp=0

5 Little Known Application Software Companies With Positive EBITDA-CAPEX Margins January 24, 2013

Posted by Ishmael Chibvuri in Latest Articles!!!.
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What is EBITDA? It’s an indicator of a company’s financial performance, which is calculated via the following:

It’s a good metric to evaluate profitability, but not cash flow, as it leaves out the cash required to fund working capital and the replacement of old equipments known as Capital Expenditures or CAPEX, which can be a significant cash expense, not recorded in the Income Statement. Therefore EBITDA – CAPEX is a more practical assessment of earnings that with just EBITDA.

It’s important to note here that since interest is excluded from EBITDA, EBITDA – CAPEX should be used in ratio with the Enterprise Value or EV.

Enterprise Value = Market Capitalization +Debt -Cash and Cash Equivalents.

Ideal Valuation Ratio = EV / EBITDA−CAPEX

Following are the stocks in the Application Software Industry With Positive EBITDA-CAPEX Margin.

AutoNavi Holdings Limited (AMAP)

Provides digital map content, and navigation and location-based solutions in the People’s Republic of China. A look at the company’s financial performance for the Trailing Twelve Months ending September 30, 2012:

Source: SEC Filings

The company reported EBITDA in LTM of approximately $47M. However, it also incurred an average cash expense in the form of Capital Expenditure of $10M, which was not recorded in the Income Statement, as shown in the Cash Flow Statement below:

(click to enlarge)

Source: SEC Filings

Therefore the company has EBITDA-CAPEX of 47-10 = $37M or with a margin of almost 25% on revenue of $151M.

As of September 30 2012, the company had 48M shares outstanding on a fully diluted basis. It also had $205M in Net cash and cash equivalents on hand. Using PPS of $11.75 from the chart below, the EV value of the company will be:

EV = 11.75*48 – 205 = $359M

(click to enlarge)

Hence the Ideal Valuation Ratio of the company will be:

EV / EBITDA−CAPEX = 359/37 or 9.70

A number below 15 indicates healthy cash flow (excluding working capital changes), I therefore recommend buying this stock.

American Software, Inc. (AMSWA)

Engages in the development, marketing, and support a portfolio of software and services that deliver enterprise management and collaborative supply chain solutions worldwide. A look at the company’s financial performance for the Trailing Twelve Months ending October 31, 2012:

Source: SEC Filings

The company reported EBITDA in LTM of approximately $18M. However, it also incurred an average cash expense in the form of Capital Expenditure of $1M, which was not recorded in the Income Statement, as shown in the Cash Flow Statement below:

(click to enlarge)

Source: SEC Filings

Therefore the company has EBITDA-CAPEX of 18-1 = $17M or with a margin of almost 16% on revenue of $106M.

As of October 31 2012, the company had 28M shares outstanding on a fully diluted basis. It also had $65M in Net cash and cash equivalents. Using PPS of $8.25 from the chart below, the EV value of the company will be:

EV = 8.25*28 – 65 = $166M

(click to enlarge)

Hence the Ideal Valuation Ratio of the company will be:

EV / EBITDA−CAPEX = 166/17 or 9.80

A number below 15 indicates healthy cash flow (excluding working capital changes), I therefore recommend buying this stock.

ARC Document Solutions, Inc. (ARC)

Operates as a reprographics company and provides specialized document solutions to various businesses. A look at the company’s financial performance for the Trailing Twelve Months ending September 30, 2012:

Source: SEC Filings

The company reported EBITDA in LTM of approximately $63M. However, it also incurred an average cash expense in the form of Capital Expenditure of $17M, which was not recorded in the Income Statement, as shown in the Cash Flow Statement below:

(click to enlarge)

Source: SEC Filings

Therefore the company has EBITDA-CAPEX of 63-17 = $46M or with a margin of almost 11% on revenue of $411M.

As of September 30, 2012, the company had 46M shares outstanding on a fully diluted basis. It also had $200M in Net Debt. Using PPS of $2.5 from the chart below, the EV value of the company will be:

EV = 2.5*46 +200= $315M

(click to enlarge)

Hence the Ideal Valuation Ratio of the company will be:

EV / EBITDA−CAPEX = 315/46 or 6.90

A number below 15 indicates healthy cash flow (excluding working capital changes), I therefore recommend buying this stock.

AVG Technologies N.V. (AVG)

Engages in the development and sale of Internet security software and online service solutions under the AVG brand name. A look at the company’s financial performance for the Trailing Twelve Months ending September 30, 2012:

Source: SEC Filings

The company reported EBITDA in LTM of approximately $99M. However, it also incurred an average cash expense in the form of Capital Expenditure of $11M, which was not recorded in the Income Statement, as shown in the Cash Flow Statement below:

(click to enlarge)

Source: SEC Filings

Therefore the company has EBITDA-CAPEX of 99-11 = $88M or with a margin of almost 26% on revenue of $335M.

As of September 30 2012, the company had 55M shares outstanding on a fully diluted basis. It also had 70M in Net Debt. Using PPS of $15.75 from the chart below, the EV value of the company will be:

EV = 15.75*55 + 70 = $936M

(click to enlarge)

Hence the Ideal Valuation Ratio of the company will be:

EV / EBITDA−CAPEX = 936/88 or 10.60

A number below 15 indicates healthy cash flow generation by company (excluding working capital changes) and therefore I recommend buying this stock.

Actuate Corporation (BIRT)

Provides software solutions and consulting services to corporate and government customers worldwide. A look at the company’s financial performance for the Trailing Twelve Months ending September 30, 2012:

Source: SEC Filings

The company reported EBITDA in LTM of approximately $27M. However, it also incurred an average cash expense in the form of Capital Expenditure of $5M, which was not recorded in the Income Statement, as shown in the Cash Flow Statement below:

(click to enlarge)

Source: SEC Filings

Therefore the company has EBITDA-CAPEX of 27-5 = $22M or with a margin of almost 16% on revenue of $139M.

As of September 30, 2012, the company had 53M shares outstanding on a fully diluted basis. It also had $75M in cash and cash equivalents. Using PPS of $5.50 from the chart below, the EV value of the company will be:

EV = 5.50*53 -75 = $217M

(click to enlarge)

Hence the Ideal Valuation Ratio of the company will be:

EV / EBITDA−CAPEX = 217/22 or 9.90

A number below 15 indicates healthy cash flow (excluding working capital changes), I therefore recommend buying this stock.

Source: http://seekingalpha.com/article/1126741-5-little-known-application-software-companies-with-positive-ebitda-capex-margins?source=email_investing_ideas&ifp=0

RIM Poised For Wave Of Analyst Upgrades January 24, 2013

Posted by Ishmael Chibvuri in Latest Articles!!!.
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RIMM Up 17% On the Week

Research In Motion (RIMM) surged on Friday, pushing its YTD gain to 25% and its three-month performance through 100%. The most recent pop in the Waterloo based smartphone maker, no doubt assisted by the over 30% short interest, was attributed to an upgrade by prominent Jefferies Analyst Peter Misek, according to a Reuters report.

The rock star status previously afforded sell-side forecasters has no doubt diminished since the dot-com bubble and the days of Analyst Henry Blodget commanding the headlines. Nonetheless, there is no other sector on Wall St. where analysts seem to hold as much influence over the price of the companies they cover as in Technology. In a market environment where product pipelines and carrier orders drive company valuations, prominent researchers often drive the price action of the stock.

Needless to say, the steady five year slide in RIMM shares has been painful for longtime investors of the company. While the recent signs of life may be reassuring for long suffering holders of the name, another two or three moves up of a similar magnitude will be required for many shareholders to break even. The stock will need to double, double again, and then double once more for those unfortunate enough to have bought and held RIMM since its peak in 2008. However, with a little help from Wall St. analysts, the share price could be making a move back up the chart in coming months.

RIMM Performance – The Last 5 Years have not Been Kind


(Click to enlarge)

(Chart Courtesy of: MarketWatch.com)

Analysts Wag the Dog when it Comes to Tech Stocks

Once the darling of Wall St. prognosticators, back when the stock was trading in the triple digits, RIMM no longer feels the love from the influential tech analysts whom hold so much sway. A quick look at analyst recommendations shows that only 6 of the 44 covering RIMM have it rated a Buy or higher. While this is an improvement over the lonely 4 analysts that had a positive rating three months ago, sentiment remains largely negative towards the company.

(Source: MarketWatch.com)

In a world that is all Apple (AAPL) all the time, both at shopping malls and with Wall St. investment banks, RIMM has been all but forgotten. Of course the company’s operating performance has not helped matters. Phones using Google’s (GOOG) Android certainly get some headlines, but much of the adoration is saved for AAPL. Which brings us to the questions: Has RIMM’s long stay in the penalty box come to an end? Can the company start eating some of AAPL’s pie?

(Source: MarketWatch.com)

Is it RIMMs Turn for Some Praise from the Street?

Projecting unit sales or evaluating operating systems is better left to those more qualified in assessing the notoriously unpredictablesmartphone market. Adam Levine-Weinberg recently put together an excellent piece on these and other topics pertaining to RIMM. He makes a compelling bull case that challenges the bearish Street consensus.

As far as RIMM’s return to relevance on morning sales calls, and in the financial press, we do have some visibility. The much anticipated launch of the BlackBerry 10, a surging share price, and recent dents to the previously impenetrable armor of Apple make for the best story line the company has had in years. At some point, possibly very soon, the once dominant smartphone maker is going to push its way back into market share discussions.

One should certainly take advice from any sell-side firm with a grain of salt; it is fair to say their interests are not always aligned with those of the average investor. Nonetheless, when it comes to the titans of technology, one would be tempting fate to not consider sell side opinion when making trading or investing decisions.

RIMM remains a far cry from once again competing seriously with its formal rivals. However, after recent developments, it is reasonable to say the competition is paying a little more attention to the Canadian company then they were six months ago. Wall St. has perked up as well. The upgrade by Peter Misek may well be the first in a wave of new analyst upgrades, and some words of encouragement for the BlackBerry maker.

RIMM Target Prices too Low

Like most market indicators, the pendulum of analyst sentiment generally over shoots the mark in both directions. Currently, the stars seem to be aligned for the much maligned RIMM to enjoy a swing to positive guidance from Wall St.

With a mean target price of just $10 from those that cover RIMM, and the stock pushing $16, something is going to have to give in the near future. The coming weeks will tell, but recent events suggest that RIMM will be the recipient of some optimistic coverage, and receive some sorely needed market attention, for the first time in what seems like an eternity.

Welcome back to the conversation RIMM, you’ve just been upgraded.

Source: http://seekingalpha.com/article/1124161-rim-poised-for-wave-of-analyst-upgrades?source=email_global_markets&ifp=0

Apple: Behaviorally, Fundamentally Attractive January 24, 2013

Posted by Ishmael Chibvuri in Latest Articles!!!.
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Apple Inc.’s (AAPL) stock price has underperformed the NASDAQ by roughly 30% over the last four months. To many investors this makes it a very attractive buying opportunity. I agree. Apple is attractive from a behavioral finance standpoint and from a fundamental valuation standpoint.

What Is Behavioral Finance?

Behavioral finance basically says market inefficiencies exist because people systematically over-and under-react to information for psychological reasons (there’s a more thorough definition at Wikipedia if you are inclined). With regard to Apple , two important behavioral finance concepts are "saliency" (for events that occur infrequently, people tend to overestimate the probability of such an event occurring in the future if they recently observed such an event) and "anchoring" (psychologists have documented that when people make quantitative estimates, their estimates may be heavily influenced by previous values of the item) (Behavioral Finance and the Sources of Alpha, Russell J. Fuller, CFA, pp13-14)

How Has Behavioral Finance Impacted Apple’s Stock Price?

Behavioral finance impacted Apple’s stock price on its historic rise to the largest market cap stock in the world, and during its significant decline over the last four months. With regard to Apple’s historic rise, equity analysts actually started to believe Apple’s earnings could continue to grow at an enormous rate for a really long-time. It was a classic example of saliency and anchoring as described above. And when visionary leader, Steve Jobs, passed away, rather than taking their foot off the gas, the analysts misinterpreted the "tribute effect." For example, when Michael Jackson died, Michael Jackson songs immediately shot to the top of the sales list on iTunes as a tribute to the tormented genius that created some of the best music in the history of the world. Similarly, when Steve Jobs died there was an unprecedented outpouring of support for his contributions to the world, and one big way in which it manifested itself was through sales of Apple products. With regard to paying tribute to Jobs upon his death, I certainly won’t soon forget images like this one:

(The windows of Apple stores around the world were filled with colorful post-it notes, each containing an individualized thank you note from someone whose life was positively impacted by Jobs contributions to the world. The scale and speed with which this type of tribute spread across the world is an example of the strong emotional attachment people have with Apple products).

In recent months, Wall Street analysts have slowly and reluctantly been lowering their earnings estimates for Apple. And I say reluctantly because I believe the behavioral finance heuristic known as anchoring (described above) has prevented them from lowering them sooner. A quick view ofYahoo!Finance shows that over the last 90 days analysts have significantly lowered current quarter, current year and next year earnings estimates. Also, Apple missed earnings estimates the last two quarters. The market is slowly admitting it was overly optimistic about Apple, and Apple’s stock price has come down significantly.

I believe behavioral finance helps explains the way Wall Street analysts forecasted Apple’s earnings, and I believe these same earnings estimates were a large driver of Apple’s stock price during its historic rise, and during its significant decline over the last four months.

Why Is Apple Currently Attractive From A Behavioral Finance Standpoint?

I believe Apple is attractive because behavioral finance has driven the price much lower (albeit at a very slow pace), and its earnings power once again supports the price going higher. Put differently, saliency and anchoring effects are finally wearing off to the point where Apple is attractive at its current price.

What Is Apple’s Fundamental Value?

Free Cash Flow (FCF) is an important metric in assessing the value of a company because it’s not easily manipulated and it demonstrates a company’s ability to create value. Free cash flow is the cash flow available to the security holders of a company. Free cash flow can be calculated by subtracting capital expenditures from cash flow from operations. In Apple’s case, in 2010 -2012, free cash flow was:

· $42.561B = 2012 FCF = $50.856 (cash from ops) – $8.295 (Capex)

· $33.269B = 2011 FCF = $37.529 (cash from ops) – $4.260 (Capex)

· $16.590B = 2010 FCF = $18.595 (cash from ops) – $2.005 (Capex)

· $30.807B = 3-year average FCF (all data from annual report, p46)

Discounted Cash Flow (DCF) Model is one important technique to value a company. The model assigns a value to a company as follows:

· Value = (FCF/WACC) / Shares Outstanding

· WACC = Weighted Average Cost of Capital, and since Apple is financed with equity (the company has zero long term debt and zero outstanding preferred stock, annual report, p63), the Capital Asset Pricing Model (CAPM) can be used to determine the WACC:

· CAPM = risk free rate + Beta x (Expected Return on Market – risk free rate)

· Risk free rate = 1.84 = yield on 10-year treasury (Bloomberg)

· Beta = 0.93 (Yahoo!Finance)

· Expected Return on Market = 8.0% = long-term assumption

· Required return on Apple = CAPM = 1.84 + 0.93 x (8.0 – 1.84) = 7.5688%

Therefore, using 2012 FCF, a zero-growth discounted cash flow model says Apple is worth:

· $597.78 = (42,561,000,000/0.075688)/940,690,000

Or, using a small expected growth rate (1.84%) and the 3-year average FCF suggests Apple is worth:

· $571.66 = (30,807,000,000/(0.075688-0.0184))/940,690,000

Can Apple Grow?

Apple absolutely has the ability to grow at a significant rate. Apple earned a second place ranking on Interbrand’s 2012 Best Global Brands list (behind only Coca-Cola), and this strong brand recognition will undoubtedly help the company grow earnings in existing and new products. To quote Interbrand "Few companies have captured our imagination, inspired such devotion, and revolutionized the way we live quite like Apple."

A segment by segment review of Apple’s business is helpful in explaining Apple’s growth opportunities.

· iPad has been the fastest growing product during the last two years going from 7.6% to 20.7% of total sales (annual report, p30). The growth potential of this segment remains enormous particularly as enterprise use of the iPad increases.

· iPhone is the largest product by sales, and has grown 71% and 87% in 2012 and 2011, respectively (annual report, p30). iPhone continues to present significant growth opportunities, however competition in the smart phone market is fierce.

· iPod sales decreased by 25% and 10% in 2012 and 2011, respectively (annual report, p30). The decrease is due in part from iPhone attrition (the iPhone is an iPod). Growth in iPod sales is challenging, however iPod continues to generate significant revenue for Apple.

· Other music related products and services grew 35% and 28% in 2012 and 2011, respectively. The segment continues to present growth opportunities, especially as new music is constantly developed and iPod users wish to listen to that music on their existing iPods.

· Mac sales grew 7% and 25% in 2012 and 2011, respectively. Macs have a loyal customer base, and present continued growth opportunities.

An important caveat with regard to Apple’s growth is to be cautious of anchoring. Just because Apple has achieved such phenomenal growth in recent years, doesn’t mean those growth rates will continue. In fact, Apple’s growth rate has been far better than most companies, and the concept of mean reversion becomes a risk, especially considering visionary leader Steve Jobs is now gone, and continued high growth becomes even more challenging with a company already as large as Apple. That said, Apple TV presents an enormous growth opportunity for the company.

Can Apple TV Contribute To Growth?

Apple TV currently generates an almost negligible amount of the company’s total revenue, yet it has the potential to become the single largest source of revenue if the company can execute.

In case you don’t know, "Apple TV allows customers to watch movies and television shows on their high definition television. Content from iTunes, Netflix, YouTube, and Flickr as well as music, photos, videos, and podcasts from a Mac or Windows-based computer can also be wirelessly streamed to a television through Apple TV." Anecdotally, I increasingly come across twenty-something-year olds that seem to spend more time on YouTube and Hulu than they do watching actual TV, and this is an indication to me that the market could one day be amenable to replacing traditional television with Apple TV. That said, Steve Jobs is gone, and without him the successful execution of Apple TV seems dramatically less likely to me. However, new CEO, Tim Cook, seems apt to lead the company in that direction anyway. In a recent interview with NBC’s Brian Williams, Cook said: "When I go into my living room and turn on the TV, I feel like I have gone backwards in time by 20 to 30 years. It’s an area of intense interest. I can’t say more than that." And if Apple TV is a success, then all of a sudden Wall Street’s ridiculously high future earnings growth estimates become much more realistic.

Graham’s Valuation Formula:

To bake expected earnings growth into a company’s valuation, I like to use a simple formula first published by Warren Buffett’s mentor, Benjamin Graham, in the 1940’s: stock price = EPS x (8.5 + (2 x growth rate)). Considering Apple’s 2012 earnings-per-share (EPS) was $44.15, and if the company grows at roughly the same rate as the market (I use a long-term capital market assumption of 8%) then Apple is worth $1,081.68:

· $1,081.68 = 44.15 x (8.5 + (2 X 8.0))

However, if we assume Apple’s earnings will grow simply at the rate of inflation (10-year Treasury = 1.84%) then Apple is worth only $537.75 (which is still more than it is trading at today):

· $537.75 = 44.15 x (8.5 + (2 X 1.84))

And if Apple TV becomes the success many people hope, it’s more reasonable to accept the average five-year earnings growth rate forecast of the 40+ analysts covering the stock according to Yahoo! Finance, which is 20.89%. And plugging this growth rate into Graham’s formula gives Apple an astounding valuation of $2,219.86:

· $2,219.86 = 44.15 x (8.5 + (2 X 20.89))

Personally, I believe it’s unlikely for any company as large as Apple to grow at this rate, and a valuation this high seems unreasonable, however if Apple TV is a huge success then this valuation all-of-a-sudden becomes more reasonable.

Risks:

Like any company, Apple faces a variety of risks that could drastically reduce its value. Some of the larger risks are described below:

· Market Decline: If the market declines significantly, Apple will likely decline with it. A struggling economy could reduce consumers’ ability to spend, which would reduce the demand for Apple products, and reduce the price of Apple’s stock.

· Failure to Innovate: Apple has only a few products (albeit blockbuster products), and if these products fail, Apple fails. The company’s success has been driven by its ability to innovate. If Apple is unable to continue to innovate then its existing products will become obsolete and the company will not be able to develop new products to meet market demands. This risk is higher than in the past because visionary leader Steve Jobs is now gone.

· Earnings Downgrades: Many Wall Street analysts have already lowered their earnings estimates for Apple, which has put downward pressure on the stock. However, additional downward revisions could cause additional selling pressure.

· Margin compression: Apple’s high profit margins will likely decrease for existing products. Competition will drive down prices. Additionally, supplier costs may increase. Both would materially impact Apple’s ability to profit.

· Poor Management: Legendary leader, Steve Jobs, is gone. The company is already changing as is evidenced by recent dividends and share repurchase programs demonstrating Apple may be struggling to find a use for all of its cash. Excess unused cash on Apple’s balance sheet is not in the best interest of shareholders, and Apple has a huge amount of cash on its balance sheet.

· Competition: Competition is fierce, particularly in the smart-phones market- Apple’s largest business segment by revenue. Competitors may develop new products that drastically reduce demand for Apple’s products, which would reduce the company’s ability to profit.

Conclusion:

Both behavioral finance and fundamental valuation metrics suggest to me that Apple stock is undervalued. I believe Apple is attractive and will outperform the market for the next 3 to 5 years, at least, and much longer if Apple TV is a success. However, I do not own shares because I believe there are better risk/reward opportunities elsewhere. Steve Jobs was the visionary leader that grew Apple into the great success that it is today, but now Jobs is gone. Apple is still a great company without Jobs, however I have less faith in the company’s ability to extraordinarily innovate and implement as it has done in the past. Steve Jobs was one of the most imaginative, creative, visionary leaders ever. He left an indelible mark on the world, and he changed the lives of hundreds of millions of people for the better.

Source: http://seekingalpha.com/article/1124081-apple-behaviorally-fundamentally-attractive?source=email_investing_ideas&ifp=0

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