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Jim Pearce: Top Picks Update
07/07/2014 10:00 am EST
Each January, we ask the nation’s top newsletter advisors for their favorite stocks for 2014. Now that we have reached mid-year, we are following up with those advisors whose performance was most noteworthy. Here, we talk with tech expert Jim Pearce, editor of Smart Tech Investor.
Steven Halpern: Our guest today is Jim Pearce, editor of Smart Tech Investor. How are you doing today, Jim?
Jim Pearce: Doing great, Steve, how are you?
Steven Halpern: Very good. What was particularly interesting about your top pick selection for 2014 was that you were the only expert to choose both the long and the short position and both did exceptionally well. Before we look at the individual stocks, could you briefly explain how you look at long and short opportunities at your newsletter, Smart Tech Investor?
Jim Pearce: I’d be happy to, Steve. Yeah, Leo and I employ a quantitative methodology for evaluating tech stocks. We call it the Boeckl Integration Quotient, which is Leo’s last name. Basically, we assign a numerical value to each tech stock that we cover based on our theory of integration, which you and I have talked about previously.
After we do that we then look at the current stock valuation for each of those companies to determine which ones are not only doing the kind of things we think they should be doing to accomplish integration, but are also fairly valued by the stock market.
But when we did that we also noticed several stocks that appeared to be grossly overvalued, so it occurred to us that. in addition to giving buy recommendations to our investors—which is what most investment publications do—we should also show them the most overvalued stocks for those investors who are comfortable either buying puts or shorting stocks.
If you think about it, those are potentially just as profitable in the short-term as the long positions. In a fact, in some cases, they’re even more profitable.
Steven Halpern: Now, on the long side, for your top pick for 2014 you chose Apple (AAPL). Could you tell us about the original rationale behind the selection and perhaps highlight some of the key developments that have occurred over the past six months.
Jim Pearce: Sure. First of all, when we calculated what we call the Smart Tech rating, or the adjusted score for all of our tech stocks last fall, Apple turned out to be one of the highest scoring tech stocks.
Our model puts a heavy emphasis on dividends, cash flow, and then a strategy score that Leo assigns based on the extent at which he feels like a company is moving in the right strategic direction to dominate one or more of, what we feel, will be the major product areas over the next ten to 20 years.
At the time, Apple had fallen out of favor with the market, there was concern about whether or not Tim Cook had the same vision of Steve Jobs. What we noticed is that Apple was still focused on producing high margin products.
Unlike a lot of other tech hardware manufacturers, Apple makes a very nice profit on its smartphones and a lot of the other devices, in addition to selling iTunes and other things that actually cost very little.
So, it was that history of focusing on high margin products and having the financial resources to continue to do that; that convinced us that Apple would be able to continue to produce those kinds of products going forward.
Since then, of course, after the first quarter earnings report, the stock shot up because of sales of their new iPhone 5, particularly in Asia, which were higher than people expected. They also announced that they were splitting the stock seven for one, which has recently occurred, so now the stock is, at least for now, under $100.
We’ll see how long that lasts, but with quantitative easing now grinding to a halt, investors now are focusing on stocks that have a solid revenue model and are able to pay dividends while reinvesting back into business and that’s what Apple is.
Steven Halpern: So, would you still recommend holding Apple for those who followed your earlier recommendation, and likewise, what would you say for new investors who are only now considering adding a position?
Jim Pearce: That’s a good question. We have a buy limit on Apple up to 95, which after the seven for one split is only slightly above where it is now. As you and I are speaking, it’s trading a little under 94, so there’s still a little bit of room to get into the stock.
We would hold it, simply because we feel that Apple is one of those stocks that, over the next several years, will continue to surprise the market to the upside, and we’ll probably bump up that buy limit from time to time, but for now, it’s bumping right up against the upper end of our buy target for it.
Steven Halpern: Now, on the short side, you chose 3D Systems (DDD), which has fallen 35% since the start of the year, in line of your recommendation to short the stock. Could you tell us a little about the initial rationale behind this short pick and explain what happened since your original bearish forecast?
Jim Pearce: Sure. Well, when Leo and I, again, did all these calculations for our tech universe, 3D Systems had the absolute lowest adjusted score of the 50 tech stocks that we rated, so, to us, it looked like a no-brainer that it was grossly overvalued.
Again, we don’t attempt to examine the intricacies of three dimensional printing and figure out which company is going to come out with the next hot model. We really look at the underlying three components of our integration mode.
So, when 3D Systems got up over $90 a share in January, I actually sent out a notice to our subscribers saying, look, if you are ever going to short this stock, now is the time. By then, its Smart Tech rating score was pretty close to zero. I mean, we felt like there was almost a 100% probability that the price had to drop.
Quite frankly, even I was surprised at how quickly and how severely it dropped. It bottomed out below $50 in April, less than three months after it traded at $96. We actually closed out our short position on March 24 at $58, so that was a very nice, short, and very profitable trade.
Now the stock is, well, actually, got down into the 40s; now it’s back up around $60, so it looks like it’s stabilizing, but we still don’t recommend going back into it yet.
Steven Halpern: So, looking out towards year-end, perhaps you could mention on new tech sector play that investors might consider, based on your rankings.
Jim Pearce: Well, Steve, I’m going to give you another long and another short—just like we did six months ago and we’ll see how they work out. Our new long position, believe it or not, is Ricoh. The over-the-counter symbol is (RICOY).
It’s trading at about $60; yes, it’s a printer company and most people believe that printer and related hardware is quickly becoming obsolete, however, they have rapidly been buying up the printer and fax and copier market in Asia, which is still growing.
We tend to think of the market here in the United States as being indicative of the rest of the world, but, in many of the Asian markets, they’re still building out their hardware infrastructure primarily for the commercial market, but nevertheless, it’s still a growing market and it’s a high margin business.
We think they have a very shrewd short-term to intermediate-term strategy of almost cornering that market, so they’re paying a current dividend yield of, I believe it’s in excess of 5% right now, so there’s a very nice yield to wait.
It’s trading at only 12 times trailing months earnings, and only 11 times forward 12 month earnings, which is less than half of the multiple for its sector, so this isn’t the kind of tech stock that’s going to double or triple overnight.
But it is the kind that a year from now, similar to how Apple has performed over the last six months, this could very easily be a $75 stock by the end of the year, which, in percentage terms, is very nice. So, Ricoh is our new long position for the second half of this year.
Our new short position, believe it or not, and this is going to surprise a lot of people is Netflix (NFLX), which, just today, Goldman Sachs upgraded to a buy rating. It jumped up $25 on that news.
It’s now trading at about $465 as you and I speak today, which, to give you an idea, puts it at about 175 times trailing 12 months earning and about 107 times forward 12 months earning, compared to a multiple of only 17.5 for its sector.
This is now the lowest scoring stock in the tech universe that we cover, similar to how 3D printing was the lowest scoring stock six months ago. Even though this is a complete contrarian type of move, to us, Netflix looks like a stock that has become overvalued. It’s the kind of company a lot of people are talking about.
They’re doing a good job of putting a lot of PR out about the programming that they’re developing, but, at the end of the day, you really got to look at each of these companies as a revenue producing business and right now we just think the market has grossly overstated the value of Netflix, so Netflix, NFLX is our new short position at $465 for the second half of this year.
Steven Halpern: Well, it’s always fascinating to hear your outlook on both bearish and bullish on the tech sector. Thank you so much for joining us today.
Jim Pearce: Okay, thank you, Steve, really appreciate it.
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