Vuru Blog

As most people know Amazon.com operates online sites that sells a wide range of products and services. Products offered on its customer-facing websites include merchandise and content purchased for resale from vendors and products offered by third party sellers. On a services front, company offers Amazon Web Services, co-branded credit cards, fulfillment, and online advertising.

Financial Strength

Revenues - Amazon reported 2Q (2014) revenue of $19.3bn (+23.2% y/y vs. +22.8% in 1Q), in line with consensus

US business revenue growth stabilized in 2Q at 26% y/y, flat over the past two quarters

Media revenues slightly accelerated to 13% y/y growth vs. 12% last quarter o EGM (Electronics and General Merchandise) revenues also accelerated inthe quarter growing at 29% y/y compared to 28% last quarter

Other business lines (mostly AWS- Amazon web services) experienced a slowdown in the quarter, growing at 38% y/y vs. 61% last quarter

International revenue grew 18% y/y, same as last quarter, representing 38% of total revenue compared to 40% last quarter

Media category revenue growth stabilized at 4% y/y FX-neutral

EGM growth experienced deceleration, growing at 20% y/y FX neutral compared to 26% last quarter

International other revenue declining 1% y/y FX-neutral from 11% last quarter. The impact is small given the size of the business (less than 1% of international revenue)

Operating income - Adjusted operating income margin was 2.1%, slightly ahead of consensus

US business operating margin declined to 3.7% compared to 4.7% last quarter, mainly due to the price cut in AWS

International business operating margin remained negative due to continued investments

Capex - Incurred $1.3bn capex in 2Q14, up 51% y/y and representing 6.7% of total revenues which is the highest ever seen and it’s total capex is expected to reach close to $5bn in 2014

Balance sheet and liquidity - During 2Q14, Amazon recorded $0.9bn operating cash inflow and there was no share repurchase in the quarter. Account payables picked up $0.3bn and the net cash balance came down to $4.9bn from $5.5bn last quarter

Guidance - Amazon guided 3Q14 mid-point net revenue at $20.6bn, slightly shorter than $20.8bn of consensus owing to investment in fulfillment infrastructure and $100mn in incremental spending on original content for Prime Instant Video

Economic Moat

Prime is one of the most valuable and important growth trend for Amazon, representing around 50% of company GMV (Gross Merchandise Volume) today. At an estimated 32mn customers (13% of total, growing at around 45% Y/Y) and high GMV but low contribution margin, the mix shift to Prime is critical to the Amazon’s success. Prime’s value to Amazon holds key as-

It creates a competitive moat around AMZN’s e-commerce business

Drives up loyalty and

Increases wallet share and captures higher customer LTV (lifetime-value)

At current pace, Prime could reach 100m customers by 2020, and even at 70% of the LTV capture it would amount to $70bn in value (nearly half of AMZN’s market cap today)

Worldwide active customer accounts increased to over 250mn in 2Q from 244mn in 1Q and growth in ARPU (Average revenue per user) after excluding other revenues from NA region accelerated to 5% y/y vs. 3% last quarter

Few Risks

Taxation-related risks - Sellers on Amazon’s Marketplace may be subject to sales tax or required to submit tax-related reporting, which could negatively impact the business

Expansion-related risks - Amazon is rapidly expanding into the global market in terms of product sourcing and infrastructure capacity. This expansion increases the complexity of the business and may place a strain on the efficiency of its operations

Investment Rationale

Amazon it is in the process of diversifying its revenue base from mostly transactions (products) to subscriptions (services) that are more recurring and predictable. It is making necessary investments in content, device and ecosystem to ramp up, but this will take time and hence over the longer term, it will remain and become a stronger and prominent e-commerce player. Amazon’s strong investment’s plans ($2bn) in the currently miniscule, severely under-penetrated and less competitive Indian e-commerce market holds immense potential over long-term.

Vuru is happy to welcome our new financial expert Nitin, he will be providing you guys with some great insight into some of the trending stocks. Our first report will be on Google (GOOGL) a stock that has continually seen a stock price increase. This is likely due to the strong management team, consistently high financial strength, competitive advantage in the advertising and search engine space, and constant injection of profits back into the company. 

Investment Rationale

Google has built one of the most effective advertising platforms in the world and serves as the backbone of the entire Internet advertising industry. It has four properties with greater than one billion monthly users - Google Search, YouTube, Android, and the Chrome browser. Despite already representing over 40% of total global advertising expenditure, it continues to find growth, primarily fueled by its long-term investments such as Google Play (Android) and YouTube. Google is making inroads into its long-sought effort to extend its search dominance into vertical search with Google Shopping and perhaps down the road, travel bookings. Google’s shares currently offer an attractive entry point (12M upside potential of 22%-30%). Google is a much more seasonal stock than many investors realize that in the last five years, Google shares have risen 31% on average in the second half vs. only 2% in in the first half.

Latest Financials (2Q14)

Revenue beats expectations -  Google’s net revenue reached $12.7 bn in 2Q14, beating the consensus est. of $12.3 bn and was driven by 23.3% growth in Google Sites revenue, 7.2% growth in Google Network revenue, and 52.6% growth in other revenue

Cost-per-click (CPC) beats Street estimates; paid clicks in-line - Google’s CPC decreased by 6% (consensus down 7%) y/y and paid clicks increased 25% (consensus 25%) y/y. Google sites saw CPC decreased by 7% and paid clicks increase 33% y/y and Networks sites saw CPC decreased by 13% and paid clicks increase 9% y/y

Traffic acquisition costs (TAC) were at $3.3 bn and TAC as a percentage of advertising revenue were 22.9%, down from 23.3% last quarter and down from 25.0% y/y

Google non-GAAP operating income was $5.1 bn (32.2% margin) compared with $4.2 bn (32.1% margin) in 2Q13 (excluding Motorola Mobile business)

Balance sheet remains solid – Google ended 2Q with $61.2 bn cash (($89.17 / share), vs. $59.4 bn in 1Q, and $5.2 bn in debt

Cash flow from operations was $5.6 bn in 2Q and Capex was $2.6 bn in 2Q14, representing 16.6% of total gross revenues as compared to 15.2% in 1Q14

Key Catalysts/Drivers for Google’s stock

Offline measurement is a major catalyst for Google to close the gap between mobile and desktop CPC. Google’s offline measurement tool is currently in beta and early test results showed that conversions are improving. It is a very important way for retailers to connect online intent and offline purchases for conversion to be measurable. Over the longer term, the success of Google Wallet should enable the company to close the loop on all mobile searches

Mobile, APAC and consumer sectors to drive growth - Traffic sent to merchants via smartphones and tablets increased over 3x y/y. Google’s business strength in countries like Japan and India is growing and is showing strong trend in travel and retail sectors

Brand advertising via digital video may inflect in the next couple of years, allowing YouTube to address the $70 bn U.S. television advertising market

Few Risks

Mobile Shift - Google has become a dominant internet platform by commanding search but users are increasingly turning to mobile devices, where app usage is more prevalent than mobile website usage, which may pose a risk to Google's core search platform

Macroeconomic environment - Shifts in the macroeconomic environment can have a some impact on the cyclical advertising industry

Competition - As one of the largest internet platforms in the world, Google faces both domestic and international competition from a large number of internet companies, including but not limited to Microsoft, Facebook, Baidu, and Yandex       

 Verdict

With Apple’s recent acquisition of Beats for approximately $3 billion they continue to show their strength in the technology market and have continually proven themselves as an innovator in the hardware and software space. But what makes Apple such a great company that their stakeholders can be proud of?

For starters, the company has grown its revenue per share for more than 10 years. Very few large-cap companies can say that. But few firms have disrupted the world as Apple has, with its iPhone, iPad and iTunes/iPod.

The stock has returned 17% this year only, and this is already adjusted for the 7-for-1 split that was experienced earlier this year. This split has made Apple’s stock more appealing for the retail investors and those looking to get more bang for their buck. Based on a quarterly payout of 47 cents, the stock has a dividend yield of 2.02%, which is quite something for a tech stock with Apple’s growth record.

The Earnings-Per-Share (EPS) growth has been supported by massive buybacks of common shares, which lowered the average share count by 7% over the year ended March 29. In April, Apple expanded its buyback authorization to $90 billion by the end of next year, from the previous authorization of $60 billion.

Typical tech investors don’t want to hear about buybacks or dividends, with the conventional wisdom being that a fast-growing company should focus on plowing its cash flow back into research and development, in order to make sure the company keeps putting out innovative products.

But Apple’s cash flow and cash buildup have shown the flaws in that argument.

Social media stocks continue to soar as both Facebook (FB) and Twitter (TWTR) revenues rise this summer

Twitter’s stock was the hot topic this week in the investment world. The world’s second largest social media company has reached a new peak in its stock price.

Twitter shares rose by as much as 30 per cent last Tuesday after the company posted their quarterly earnings. The numbers showed the company keeps adding new users (up to 271 million at last count) and better still, is squeezing more and more money out of advertisers for all those timeline views. This has led to the company doubling their revenue, which took in $312 million in the three months up to the end of June. That’s an increase of 124% over the same period a year ago.

Twitter still lost $142 million in the quarter, more than three times as much as the same period a year ago. But investors seemed to focus on the positive this week, driving Twitter shares up to their best day since the company had its IPO last year.

A similar reaction from investors was seen last month with the shares of Facebook (FB) going up to a new high of $73.22 per share and Facebook continues to lead the social media industry with 1.32 billion total users.

Everyday investors are looking for ways to find the next Google, Amazon, FB and Twitter. It seems like overnight these companies are booming and with it their stock is increasing. Those that bought the stocks at the right time have seen huge returns that many didn’t expect. But how are gurus like Warren Buffet able to constantly make these great finds to the point where it can’t be called luck?

They find companies that people often write off as no good or not able to make them money in the short run. What compels them to buy these companies is their intrinsic value that is often overlooked and when it is finally realized these early investors are able to make high returns. Google for example has seen a stock price increase of about $350 per share in just 5 years time. These savy investors are looking at the hidden values of these companies and are earning big for their finds.

How can the average investors out there learn from these experts to potentially get returns that constantly beat the market? They need to follow some simple rules to find value in overlooked companies.  Below you will 7 value signs that you can leverage to help you better invest.

Value Sign 1: Earnings Per Share - Look for companies with a pattern of earnings growth and a habit of reinvesting a significant portion of earnings in the growth of the business. Compare earnings per share with the dividend payout. The portion that isn’t paid out to shareholders gets reinvested in the business.

Value Sign 2: Price-Earnings Ratio - Look for companies with P/E ratios lower than other companies in the same industry.

Value Sign 3: Dividend Yield - For long-term investments, look for a dividend to generate income to reinvest in the company. The target: a pattern of rising dividends supported by rising earnings.

Value Sign 4: Book Value - For stocks with good long-term potential, look for book value per share that is not out of line with that for similar companies that are in the same business.

Value Sign 5: Return on Equity - Look for a return on equity that is consistently high, compared with the return for other companies in the same industry, or that shows a strong pattern of growth. A steady return on equity of more than 15% may be a sign of a company that knows how to manage itself well.

Value Sign 6: Debt-Equity Ratio - Consider companies that have debts amounting to no more than about 35% of shareholders’ equity

Value Sign 7: Price Volatility - Whenever you assume the risk that goes with an oversize beta (measure of a stock's volatility in relation to the market), it should be in expectation of receiving an oversize return.

It happens too often. The herd mentality grips Wall St. as investors follow stock analysts like lemmings off a cliff. The only difference is that the analysts profit from your untimely end. For small investors it quite literally, pays to ignore them.

We’re going to show you that there’s a certain mythology around stock analysts. Their recommendations are not designed with the individual investors’ interests in mind. Instead, they are guided by each analysts' biases and are ultimately self-serving. 

On the surface, it seems like these analysts are usually right. The 10 stocks that analysts rated as a “buy” and “strong buy” a year ago delivered a 24% return. This seems good compared to the S&P 500, which gained just 13%.  

But, if you had actually bought the 10 stocks that Wall Street was most pessimistic about, those stocks gained 32%. (source) It’s obvious that their recommendations will not make you profit more in the market; in fact it results in poorer performance.

Clearly, it’s best not to trust the professionals but, investors are led to losses as they follow analyst’s recommendations year after year. A case in point is the financial crisis of 2008. But, why do their stock picks perform so poorly?

Very simply, analysts are human and their research is warped with conflicts of interest as well as psychological baggage. Last year, the consulting firm McKinsey looked at a quarter-century of analysts’ earnings forecasts and compared them to actual earnings. Every year, sell-side analysts were over-optimistic and slow to revise their forecasts.

This can be explained by looking in terms of the interests of these banks and funds. To buy a certain position it usually takes weeks since they must spend a large amount of money and are subject to regulations that limit the amount of stocks they can purchase at any given time. Analysts will use their clout and supposed “expertise” to manipulate investors to free up stock to purchase.

Moreover, fund managers are measured by their performance quarterly where they must hop from one hot stock to another praying for profitability so they can keep their job. Thus, they are not interested in their long-term performance as most individual investors are.

How you can play in this market? One thing is for sure, if you play with the big boys, you will get killed. Luckily, it pays to be small and stealthy.

Funds are subject to far more rules and regulations than you are. They are usually too big to buy stocks from small companies with small market caps. Others are restricted funds, which are not allowed to buy foreign stocks, and are restricted to stocks listed in the S&P 500. Thus, they will often miss good opportunities. (source)

If you’re looking for success in the stock market, there are couple things you need to do:

Ignore the noise. As shown, analysts’ stock tips and recommendations are no better than a pile of bovine excrement. Take them with a grain of salt. 

Make sure you do your research. Nothing is worse than walking blindly into a stock. Know as much as you can about the industry and the company.

Microsoft is a fundamentally strong company despite being Apple and Google’s ugly cousin. It displays good management of cash through its cash return on invested capital and positive free cash flow. It also boasts healthy net profit margins and a satisfactory capital expenditure ratio.

Despite its financial strength, Microsoft’s major weakness can be seen in its ill-guided foray into the search arena with its Bing search engine. Since its inception in 2009, Microsoft’s Bing has managed to rack up losses of approximately $5.5 billion.

At Bing’s launch, Microsoft planned to halve Google’s market share of worldwide search. So far they have managed to capture 14.7%. This growth is deceiving since much of Bing’s users are cannibalized from Yahoo, its search partner while Google’s dominant position is largely unchanged year over year.

The biggest problem to Bing’s success is that Microsoft doesn’t just want to capture more users, but they want to change how these users search. Bing answers questions in a simple natural language, which is not always effective for users who are use two to three word searches in Google. 

Thus, Microsoft and its analysts should view Bing as a gateway to a new semantic marketplace on the web. By effectively marketing themselves as distinctly separate from the traditional conception of search that is dominated by Google, Bing will find it much easier to attract users who will supplement their Google searches with Bing. 

The flaw in this strategy is that users simply don’t know this about Bing and Google rarely fails. These two factors seriously impede Bing's success even if Bing truly delivered better search results.

Wal-Mart and Target’s low prices should make them perfect in bad times as families seek low cost but quality merchandise. But, the U.S. economy is in murky waters. Increasing unemployment, decreasing GDP growth and inflation have made it difficult for retailers to survive.

For both companies, poor sales have put many investors in doubt. Are either investable?

Wal-Mart has just been greeted with another quarter of negative same-store sales while Target’s disappointing sales growth have driven down their share by 14 percent this year.

While both retailers have been significantly weakened, Wal-Mart seems to be the most likely one to improve its fundamentals as they expand overseas.

Target’s low-priced, chic designer wear have lost their competitive advantage as rivals have started stocking similar brands. Kohl’s (KSS), J.C. Penney (JCP) and Forever 21 all compete with Target for customers that are looking for stylish clothes at a low price. (source)

With increasing competitors, Target has lost its image as the high-end cousin of Wal-Mart. This has damaged its margins and competitive advantage. Instead of addressing core issues to the business, their recent moves have sought to increase sales to slow the bleeding but fail to come up with a cure to its weakening economic moat.

Target is opening fewer stores these days while they have resorted to adding groceries to boost sales and adding a five percent discount if customers use a Target credit card. But, these are temporary measures. The future of the company is in doubt if they cannot find a sustainable competitive advantage.

In Wal-Mart’s battle for profitability and investors, it has the edge over Target as they expand outside of North America where growth has stagnated. Wal-Mart continues to grow its international operations in Mexico, China and Brazil. These emerging markets are high growth areas and will drive up Wal-Mart’s sales and the stock price.

Although China only accounts for 10% of Wal-Mart’s international sales, it is set to become one of the biggest retail markets globally for the company. Since 2007, Wal-Mart China has been maintaining double-digit growth.

Below are three undervalued tech stocks that are trading at cheap valuations, according to the growth price (fcf) using a 15% discount rate, and that have strong balance sheets. They have a strong liability to assets ratio, which makes them financially healthy to withstand any dangers in the future.

We hope you’ll use this report as a starting point in your analysis.

Cisco (CSCO)

Cisco Systems, Inc. designs, manufactures and sells Internet protocol (IP)-based networking and other products related to the communications and information technology industry worldwide. It offers routers that interconnect public and private IP networks for mobile, data, voice and video applications.

In terms of its fundamentals, it looks strong where it isn’t overpaying its dividends despite healthy net profit margins at 15%. Cisco is also capital-intensive but it has been able to keep an exceptional amount of cash.

(Click charts to expand)

Cisco’s economic moat has been maintained at acceptable levels as it boasts strong gross margins at 61.40%.

But, Cisco has slashed its long-term forecasts due to an increasing number of rivals and worrisome outlook for government and corporate tech spending. Troubles in the finance sector may also lead to a tech spending slowdown, but future growth margin projections of 60% are still above industry estimates. (source)

If tech spending continues uninterrupted and Cisco can maintain its competitive edge, it is defiantly a stock worth looking into.

Undervalued by: 40.10%

TL-to-TA: 0.46

See the Analysis on CSCO's Fundamentals

QLogic Corporation (QLGC)

QLogic engages in the design and supply of storage networking, high performance computing networking and converged networking infrastructure solutions. It offers various host products; including fiber channel and Internet small computer systems interface host bus adapters.

QLogic may be building PCIe flash cards. Given that QLogic makes Fibre Channel HBAs, InfiniBand adapters, and Ethernet CNAs that plug into a server’s PCIe bus, adding a PCIe flash card product, either stand-alone or integrated with these adapters looks like a logical move and one that would be supported by QLogic’s reseller channels. (source)

QLogic’s free cash flow has consistently been impressive. Its management of cash (167.3m in free cash flow) and shareholder’s equity has led to a strong cash return on invested capital with 57.53% and a return on equity of 23.14% in the 2011 fiscal year.

Low capital intensity has also been maintained where the capital expenditure ratio had been reduced from 44.64% in 2010 to 16.72% in 2011.

Undervalued by: 30.52%

TL-to-TA: 0.21

See the Analysis on QLGC's Fundamentals. 

Peerless Systems Corporation (PRLS)

Peerless Systems Corporation holds the right to license the imaging technology and third party imaging technologies. The company is also pursuing other investment opportunities in order to diversify its offerings.

Although it boasts a strong balance sheet, second quarter results shows that revenues were $0.4 million for the first three months compared to $0.7 million of the second quarter of 2010. They experienced a decrease in licensing revenues due to the declining use of its technology and the earthquake in Japan. (source)

However, its competitive advantage is still impressive with a 66.97% net profit margin as well as a strong pricing power is 69.88% in the 2011 fiscal year.

If Peerless can continue to manage its existing customer relations as well as focus on finding new venture opportunities or acquiring an existing business, it may be able to regain lost ground.

Undervalued by: 99.38%

TL-to-TA: 0.19

There are many variables out of a cruise line’s control that can devastate a fiscal quarter or even a year. This year has been no exception.

Political turmoil threatened Mediterranean cruises due to conflicts in Libya, Tunisia and Egypt, while bad weather from Hurricane Irene forced cruise lines to alter their itineraries.

These cruises lines have also been subject to fuel price volatility as well as a sluggish economy. In mid-August, on rising fuel and geopolitical events, Carnival fell 25% while Royal Caribbean stock lost 45% of its value. (source)

Loyal and wealthy passengers can remove some of the uncertainty within the industry by paying more for tickets in order to offset fuel costs as well as continue travelling through different itineraries despite regional instability. Persistent worries on macro-economic conditions have luckily not prevented the affluent segments of the population from splurging on vacations.

Carnival may represent a buying opportunity if its customers can continue to spend money on vacations and offset political dangers and high fuel prices. However, it remains to be seen what effect the new Obama tax will have on the spending habits of the rich.

Carnival Corporation (CCL)

Carnival Corporation operates as a cruise and vacation company, provides cruises to various destinations and holds a large portfolio of cruise brands. Carnival recently reported a quarterly profit rise, which had been aided by higher spending per passenger in North America.

Future conditions may look like smooth sailing as advance bookings for 2012 have been at a higher price than this year. Despite a 45 percent jump in fuel costs, the higher revenue yields last quarter more than offset the fuel costs. (source)

Chief Financial Officer David Bernstein has also said that Carnival has $343 million remaining on its share repurchase program and dividends. (source) A 10-year analysis on Carnival’s dividend history reveals that dividends have been regularly paid out, but its yield has fluctuated.

(Click charts to enlarge)

Carnival also boasts a good balance sheet with TL-to-TA at 0.39 as well as a strong retained earnings growth at 9.22%.

Royal Caribbean (RCL)

A look at Carnival’s competitor, Royal Caribbean, shows that Carnival may be the better pick. Royal Caribbean Cruises operates in the cruise vacation industry worldwide and owns five cruise brands with various itineraries and amenities.

Some have argued that Royal Caribbean, with a current low P/E ratio, may represent a good opportunity to buy an undervalued stock. However, the premium paid for Carnival stock may deliver more value for its investors given its stronger fundamentals.

A quick look at RCL’s fundamentals show that its economic moat, in terms of its competitive advantage and pricing power, is significantly weaker than CLL.

Carnival’s competitive advantage (net profit margin) has been maintained around 13.67% while its pricing power (gross margin) hovered around 37.16% in the last fiscal year.

RCL is not better off where net profit margin was 8.11% and its gross margin was 33.98% over the last fiscal year. 

Below are our picks for the top three companies in the semiconductor industry. We’ve used our proprietary value screening tools to identify the best stocks in the industry according to its valuation as well as its fundamentals.

The global semiconductor market was hit particularly hard by the economic downturn with consumers holding back on purchasing electronic equipment and vehicles.

In the short-term, worldwide semiconductor revenue for 2011 has slowed and is expected to reach US $299 billion, a drop of 0.1 percent compared with 2010. This can be attributed to excess inventory, manufacturing over-capacity and slowing demand due to economic weakness. (source)

This is concerning but, if you’re not too worried about a double-dip recession and uncertain global macroeconomic conditions then here are three stocks that are undervalued and show strong fundamentals.

We take a look at 10 years of fundamental data and grade them according to its valuation and overall financial health. These stocks are undervalued according to their growth price (FCF) with a 15% discount rate.

Click the report at the bottom of each stock analysis to dive deeper into the stock’s valuation and financial data where we chart the fundamental trends for each of them. 

Tessera Technologies, Inc. (TSRA)

Tessera Technologies develops, licenses and delivers miniaturization technologies and products for electronic devices worldwide. Its micro-electronics section offers semi-conductor packaging technologies encompassing interconnect and substrates and thermal management technology.

Pro:

Management of cash has been spectacular since 2002. Cash return on invested capital has been 43.13% in 2010 while positive free cash flow has gained year on year with 96.30m in 2010.

Healthy financial strength with a very strong balance sheet (TL-to-TA 0.07) and consistent reinvestment of profits with 31.79% retained earnings growth last fiscal year.

Con:

Tessra Technologies provided financial guidance for the third quarter ending Sept. 30, 2011. Total revenues are expected to be approximately $60 million, which declined compared to second quarter 2011 total revenue of $70.7 million. (source)

Return on equity has been steadily declining since 2006, reaching 8.63% in 2010.

Undervalued by: 155.24%

Vuru Grade: 89.07/100

See our full analysis on TSRA’s fundamentals and valuation.

Applied Materials Inc. (AMAT)

Applied Materials provides manufacturing equipment, services and software to the semiconductor, flat panel display, solar photovoltaic and related industries worldwide. Its Silicon Systems Group offers a range of manufacturing equipment used to fabricate semiconductor chips or integrated circuits.

Analysts’ outlook on AMAT remains mixed as Goldman Sachs downgraded it to a sell rating with a $10.50 target. Meanwhile, analysts at Oppenheimer upgraded shares from a “perform” to an “outperform” rating last Thursday with a $16.00 price target. (source)

Pro:

Applied Materials announced its quarterly results on Wednesday, August 24th, reporting a $0.35 EPS, which beat Thomson Reuters consensus estimate of $0.33 EPS.

Reducing capital intensity where capital expenditure ratio has decreased to 18.03%.

Consistent dividends since 2005 with a current dividend yield of 2.67%.

Con:

Net profit margins have been declining since 2008 where it reached 9.82% in 2010. Compare this to the net profit margins in 2004 to 2007 where it has hovered around 17%. 

Undervalued by: 41.99%

Vuru Grade: 84.24/100

See our full analysis on AMAT’s fundamentals and valuation.

Supertex, Inc. (SUPX)

Supertex develops, manufactures and markets high voltage analog and mixed signal integrated circuits primarily in Asia, the US and Europe. The company offers high voltage analog multiplexer switches as well as high voltage amplifier ICs to drive optical micro-electro-mechanical systems for the telecommunications market for use in optical switching applications.

Supertex recently introduced the MD2134, a high-speed source driver to be used in a pulsed current waveform generator for medical ultrasound imaging machines. This compliments its existing products and is optimized for delivering high-resolution images in high performance and low power ultrasound machines. (source)

Pro:

Healthy economic moat with competitive advantage, pricing power and capital intensity improving over the years. Net profit margins at 14.77% in the last fiscal year. Also, strong pricing power with gross margins at 54.33%.

Very strong balance sheet (TL-to-TA 0.13) and a strong retained earnings growth at 6.29%.

Con:

Return on shareholders’ equity has been steadily declining since 2008 reaching 6.37% in 2011.

Undervalued by: 33.72%

Vuru Grade: 83.25/100

For some investors, it’s important to look for a strong dividend history when searching for potential stocks since dividend investing is a tried and true strategy for steady returns in uncertain times.

But equally important is also acquiring them at a bargain.

Here are three stocks that are undervalued according to their growth price by using a 15% discount rate as well as a strong history of dividends.

More information on each stock’s dividend history can be found through the links at the bottom of each stock analysis. 

Occidental Petroleum Corporation (OXY)

Occidental Petroleum Corporation operates as an oil and gas exploration and production company primarily in the United States.

OXY has a modest yield, minimal debt and better earnings growth than its peers. With growing earnings, OXY could afford to continue raising its dividend given its earnings growth. (source)

Pro:

Undervalued by 42.12% according to growth price (FCF). Growth rate assumed by market is 0.31%.

Good management of cash. Positive free cash flow has been growing while cash return on invested capital has been improving over the years.

Strengthening balance sheet. Debt-to-equity ratio is 12% while its interest is covered 31 times.

Con:

For OXY, a particular concern is the civil war in Libya. In the past, foreign companies were required to provide 90% of their output to Libya’s state-run oil company. If they can renegotiate these deals, OXY will benefit greatly. However, analysts say that production might not return to pre-crisis levels until 2013. (source)

Dividend Yield:

Click to enlarge

See our full report on 10 years of Occidental Petroleum's dividend history.

Telefonos de Mexico (TMX)

Telefonos de Mexico provides telecommunications services primarily in Mexico by offering local telephone service, domestic and international long distance services and interconnection services to long-distance, local and mobile phone carriers.

Pro:

Undervalued by 51.45% according to growth price (FCF).

Economic moat has been consistently maintained with a healthy net profit margin of 13.55% and strong pricing power over the years with a gross margin of 60.14%.

Strong history of stock buybacks over the years. 1.07% of stock bought back in 2010.

Con:

Balance sheet has been growing steadily weaker since 2007. TL-to-TA 0.72 in 2010.

Mexico’s antitrust regulator said last Wednesday that TMX’s dominance in the market for completion of phone calls to fixed lines opens up the possibility of asymmetrical regulations and tariffs. (source)

Dividend Yield:

Click to enlarge

See our analysis on 10 years of Telefonos de Mexico's dividend history.

Harte-Hanks (HHS)

Harte-Hanks operates as a direct and targeted marketing company that provides direct marketing services and shopper advertising opportunities to local, regional, national and international customer and business-to-business marketers.

Trillium Software, a business of Harte-Hanks, announced an agreement with AIR Worldwide, the scientific leader and most respected provider of catastrophe risk modeling software to provide more precise geocoding through the integration of Trillium Software’s geospatial capabilities. This will improve data quality to the risk assessment of earthquake, cyclones, flood and terrorism. (source)

Pro:

Undervalued by growth price (FCF) and stability price by 68.62% and 75.43%, respectively.

Excellent return on equity at 12.24% in 2010.

Positive free cash flow has been consistently exceptional since 2001.

Con:

Economic moat is weakening. Its net profit margin (6.23%) has been thinning as well as capital expenditure ratio (32.55%) has been increasing over the years.

Retained earnings growth has been declining since 2008 and has reached 2.83% in 2010.

Dividend Yield:

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Warren Buffett’s Berkshire Hathaway (BRK.A) announced that it has recruited Ted Weschler, a 50-year-old hedge fund manager from Charlottesville, to help manage Buffett’s equity holdings. Weschler’s Peninsula Capital manages about $2 billion in assets with a narrow portfolio of mostly mid-cap stocks.

But, is he a good choice?

We’ve used our proprietary tool to analyze some of Weschler’s holdings. It remains to be seen if Weschler can achieve the same type of success as Buffett. More than half of Weschler’s disclosed portfolio is in DirectTV (DTV), W.R. Grace and Co (GRA) and DaVita (DVA).

Our analysis shows that these stocks do not boast incredibly strong fundamentals nor are they compelling stocks to buy. DaVita may be the most promising out of the three while DirecTV is facing increased competition and W.R. Grace is preparing itself for an onslaught of lawsuits.

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DirectTV (DTV)

DirecTV provides digital television entertainment in the U.S. and Latin America through direct-to-home digital television services as well as multi-channel video programming distribution services.

A particular concern is that there are a growing number of people who are dropping their TV subscriptions and opting for more web-based programming. Live sports and premium channels on DirecTV are motivating people to stay subscribed but these shows are slowly moving onto the web. DirecTV has attempted to staunch the migrating customers by developing an app that moves programs that are stored on DVRs onto the iPad. (source)

Pro:

Excellent cash return on invested capital. Risen from 12.96% in 2006 to 23.33% in 2010.

Improving positive cash flow since 2001 where it has jumped from -1.55B to 2.79B in 2010.

Con:

Grossly overvalued, if DTV cannot compete with the move toward web-based programs. Market currently assuming a 14.86% growth rate.

Very weak balance sheet. DTV has been taking on debt since 2006 with current Tl-to-TA 1.01.

See Our DirecTV Stock Analysis. 

W.R. Grace and Co. (GRA)

W. R. Grace & Co. engages in the production and sale of specialty chemicals and materials worldwide. Its Grace Davison offers fluid catalytic cracking catalysts to produce transportation fuels, such as gasoline and diesel fuels and other petroleum-based products.

W.R. Grace operated the chrysotile asbestos mines in Libby, Montana, for decades and filed for Chapter 11 reorganization in 2001 to protect it from more than 100,000 personal injury claims. Once it leaves bankruptcy protection, Grace will pay creditors in full and set up a trust to pay victims of asbestos poisoning. (source)

A look at the past 10 years reveals a mixed performance.

Pro:

Slowly began reinvesting profits in 2005 and has been rising up to 2010.

Positive free cash flow has been improving from 2007 where it reached 214.80M in 2010.

Con:

Disappointing cash return on invested capital from 2008 (-4.57%) to 2010 (7.89%).

Little indication of an economic moat, thin profit margins, mediocre pricing power and highly capital intensive

See Our W.R. Grace and Co Stock Analysis. 

Davita (DVA) 

DaVita provides dialysis services for patients suffering from chronic kidney failure. The company operates kidney dialysis centers while providing related medical services primarily in dialysis centers and in contracted hospitals.

It has recently announced the launch of its Biorepository Services. The Biorepository contains collections of biological material and their pertinent databases for the purpose of research. This investment will allow the company to supply central laboratory services outside of renal care, which will broaden its current therapeutic offerings. (source)

Pro:

Profits have been reinvested year after year since 2002. As of 2010, retained earnings growth is 17.55%.

Consistently excellent return on equity and positive free cash flow since 2001.

Con:

DaVita is in a relatively competitive industry. It hasn’t been able to improve its net profit margin through the years. It has hovered around 6-10% since 2001.

Highly capital intensive where the capital expenditure ratio has been rising over the years, it stands at 67.44% in 2010.

Amazon (AMZN) has reportedly been in talks to launch a Kindle e-book library lending system that would allow tablet users to pay a fee and access the entire Amazon digital library. This move has been considered by many analysts to make Amazon the “Netflix (NFLX) for books.”

In terms of price, Amazon’s e-book service is rumored to be a value-add to incentivize customers to join the $79.00 yearly plan. (source)

But can Amazon successfully implement a subscription based plan?

The answer isn’t clear for potential investors. Amazon will face the same difficulties that have plagued Netflix and its struggle with the content providers and it is also vulnerable to different issues, which can stymie its bid for e-book dominance.

The collapse in negotiations between Netflix and Starz Entertainment may be foreshadowing of the type of troubles that Amazon will face if the company attempts to implement a similar subscription-based service.

For Netflix, it is the content providers that have the upper hand in the business where Netflix has become beholden to the whims of Starz, CBS and more. These content providers can look to other distribution channels or sell their content directly to the end customers. Either way, Netflix, and perhaps Amazon, are subject to the whims of these providers. (source)

Similarly for Amazon, book publishers need to agree to the plan. This battle has already taken place over e-book pricing as well as digital issues, which have plagued Amazon’s Kindle lending program. To assuage the concerns of the publishers, it is rumored that Amazon is providing them with a considerable sum in order to move forward with the rental service. (source)

Despite the similarities, Amazon may be in a better position than Netflix. Amazon has credit card accounts, customer loyalty and the tablet device to improve its chances at success.

But, it is not in the clear yet since it faces trouble elsewhere. The company will have to provide newly released books, which usually come at a higher premium. The Amazon tablet needs to be popular among consumers and it has to effectively neutralize the competition from other book providers. The biggest threat may actually come from Apple (AAPL), which will have no choice but to respond if Amazon is successful in this new venture. (source)

Should investors be looking toward Netflix or Amazon?

It’s clear that both companies are overvalued and show mediocre fundamentals. Netflix’s vulnerability to its content providers makes it a less enticing investment choice. But, if Amazon can effectively leverage its existing assets with the launch of its new tablet as well as stay dominant among the retailers, its fundamentals will improve in the future.

Netflix 

Investors should remain wary despite a healthy cash balance and strong returns on its investments. Netflix will certainly be facing many difficulties in the foreseeable future. It seems to be losing its edge in the market while remaining overvalued by 71.26% based on its growth price (FCF).

Moreover, the cost of content is going up while its exclusive hold on the videos is decreasing, which is opening up the market for competitors such as Google (GOOG), Amazon and Microsoft (MSFT) to pursue opportunities in video. (source)

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See Our Netflix Stock Analysis. 

Amazon 

The new Amazon Kindle tablet is not expected to be an Ipad killer but Amazon will be able to offer fresh competition and compete head-to-head with iTunes and its app store with its large collection of multimedia offerings.

The tablet’s low price ($250) undercuts premium tablets while also allowing the company to compete with other low-cost tablet makers by leveraging its current assets such as its existing customers, its marketing muscle and potentially the book publishers.

The launch of its tablet may place Amazon in a number two position to Apple and strengthen its bottom line, but it's important to note that despite any hope of tablet dominance by Amazon, it is unlikely.

Amazon’s dominance will be found elsewhere. The vulnerability of Best Buy (BBY) and the demise of the big box stores is freeing up the market share for non-traditional retailers such as Amazon.

Thus, its new tablet as well as the decline of big-box stores may allow Amazon to strengthen its fundamentals in the near future. 

Despite all the hype behind the US-based companies that IPO-ed this year, more than half of them are trading below their offer price. This can be partly explained by the overall decline of the stock market, which has been dropping for the past two months.

On their debut, Pandora (P) popped out at 8.9%, Epocrates (EPOC) gained 37%, LinkedIn (LNKD) rose 109% and Zillow (Z) jumped 79%. While their latest decline can be attributed to macro-economic worry such as Greece’s sovereign debt crisis and the U.S. economy, does this drop mark a buying opportunity for these companies? (source)

Pandora stock has slid 10% in the last two days as competition has intensified with the launch of the iHeartRadio app and website, which also lets users create customized stations. Clear Channel’s iHeartRadio app will allow users to create personalized station categories 10 times the size of what Pandora offers with 5 times more artists and no caps on play time, and it's initially advertisement free. (source)

Moreover, Pandora has yet to prove itself as a viable long-term business model. The majority of its users sign up for ad-supported free service but its ad revenue ($119 million) is not enough to cover its costs while it must also contribute 45% of its revenue to royalties. (source)

In terms of the social media space, LinkedIn has historically been boring as it is constantly overshadowed by the more fashionable and exciting Facebook and Twitter. This changed as soon as it IPO-ed; however, its current valuation is questionable.

LinkedIn makes $12 million in profit a year but investors have treated it as a $9 billion company. Although the market for a hiring solution is huge, it is unclear how much market share LinkedIn can realistically take given the pre-existing competition that has existed long before LinkedIn. (source)

However, there does seem to be some headway that could potentially drive more jobseekers to LinkedIn. The company recently announced a partnership with Taleo (TLEO) that would streamline a job seeker’s ability to apply for around 5 000 companies by auto-filling information from Taleo’s “Universal Profile” service. (source)

These hot stocks will soon cool and may end with more reasonable price-earnings ratios. Presently, the uncertainty behind their business models as well as the hype behind them does not make them smart investments.

However, there are plenty of buying opportunities out there. Here are 3 stocks that are both undervalued and are more prudent choices than the latest IPOs. The following stocks are undervalued according to their growth price (FCF) using a 15% discount rate.

Microsoft (MSFT)

Microsoft is currently undervalued by 12.94%. Its new Windows 8 operating system received generally good reviews from developers and tech blogs and may lead Microsoft into the age of ‘cloud computing’ by tying together its software for PCs, tablets and phones.

If Microsoft can unload Bing while increasing its dividends, it will become a more attractive stock and deliver more value to its shareholders.

See Our Microsoft Stock Analysis. 

Oracle (ORCL)

51% of Oracle’s revenue originates from software “maintenance” deals, which gives it greater stability than other software vendors. This maintenance stream will allow it to control it costs, navigate choppy waters and protect itself better than any of its mega-cap peers especially in a difficult macro-economic decline. (source)

A 10-year financial history reveals an impeccable management of cash and its investments and a consistent maintenance of a strong economic moat.

See Our Oracle Stock Analysis.

Intel Corporation (INTC)

Intel is currently undervalued by 28.36%. It boasts a very strong balance sheet with a TL-to-TA 0.22, excellent management of cash and maintenance of a healthy profit margin and pricing power.

Intel’s new mobile processor will power Google’s (GOOG) Android “Honeycomb” operating system. This is a mutually beneficial deal where Google gets another major processor building chips for its platform while Intel is given an opportunity to provide chips for the broadest smartphone platform in the world. (source)

In uncertain times, it's important to look for companies with a strong competitive advantage which will ensure their staying power in the years to come. We’ve searched through over 5,500 stocks using our proprietary tool to find undervalued stocks with a strong economic moat.

These stocks are undervalued according to their growth rate (FCF), using a 15% discount rate. To find a strong economic moat we’ve looked at each company’s competitive advantage, pricing power and capital intensity. 

However, the economic moats of these companies are not permanent. Investors should be vigilant of products and patents that can be copied or expire. We hope you’ll use this list as a starting point for your analysis.

Forest Laboratories Inc. (FRX)

Forest Laboratories develops, manufactures and sells branded and generic forms of drug products. Its principal products include Lexapro which treats depression in adults and adolescents, Namenda for the treatment of Alzheimer’s and Bystolic for the treatment of hypertension.

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Pro:

Undervalued by 86.22% according to its growth price (FCF) as well as 9.54% by its stability price.

FRX’s management has invested its financial resources incredibly well. Its cash ROIC (52%), return on equity (19.04%) and free cash flow has been excellent since 2002.

Steadily buying back stocks since 2005.

Con:

Lexapro comes off patent in March 2012 and has accounted for 53% of FRX’s sales in the last quarter.

FRX’s Namenda drug is also at risk of generic competition by early 2015, which puts a further $1 billion in question. (source)

Competitive advantage (net profit margin): 23.68%

Pricing power (gross margin): 78.19%

Capital intensity (capital expenditure ratio): 3.67%

See our report on FRX’s economic moat here

Portugal Telecom SGPS S.A. (PT)

Portugal Telecom provides telecommunications services in Portugal, Brazil and Africa. They offer fixed line telephone services, mobile telecommunication services, as well as internet-related services.

Its retail accesses are up by 6.6%, broadband customers have increased by 11.5% and pay-TV customers increased 31% year-on-year. CEO Zeinal Bava foresees improving revenue trends, significant cost reduction and tight CapEx control within Portugal. (source)

Pro:

Highly consistent pricing power over the years. Its gross margin has risen from 73.71% in 2009 to 80.56%.

Improving return on equity since 2004 (18.49%) through 2010 (135.50%)

Very strong dividend history. PT’s dividend yield has been increasing since 2001.

Con:

Mediocre past performance since net profit margin and capital expenditure ratio have only been impressive from 2010.

Competitive advantage (net profit margin): 155.52%

Pricing power (gross margin): 80.56%

Capital intensity (capital expenditure ratio): 19.84%

See our report on PT’s economic moat here.

Gilead Sciences Inc. (GILD)

Gilead Sciences is a biopharmaceutical company which engages in the discovery, development and commercialization of therapeutics for the treatment of various life threatening diseases. Its products treat HIV in adults, hepatitis B, invasive fungal infections and more.

Pro:

Currently undervalued by 32.57% according to its growth price (FCF).

Stock buybacks since 2008 with 6.95% bought back in 2010.

Good balance sheet, slowly taking on more liabilities but current TL-to-TA ratio of 0.49 is still healthy.

Con:

Investors should wait for the results of its HIV pill (Quad) as it may be effective in clinical trials but will need to show superiority over the Reyataz regimen to convince investors of its commercial potential. But, RBC analysts are skeptical where they have given the pill a 25 percent chance in showing superiority. If approved, sales of Quad have been forecasted as high as $1.53B by 2015. (source)

Competitive advantage (net profit margin): 36.50%

Pricing power (gross margin): 76.48%

Capital intensity (capital expenditure ratio): 2.13%

The last couple weeks have not been kind to US airline stocks as both Mother Nature and investors have thoroughly beaten down them down.

Hurricane Irene cut into US Airways’ operating income by as much as $10 million while Delta’s August net profit cost it $15 million in monthly net profit. (source)

On Tuesday, fears of a second U.S. recession sent airline stocks plummeting as air travel outlook looked weak. Globally, the airlines’ second quarter financial results have declined by 60% while fuel prices are up 50% from last year. (source)

But, is the latest fall grounded in reality?

Looking back, it’s certainly been a challenging decade for airlines since 9/11. US airline revenue fell $23 billion from 2000-2002. Between December 2002 and October 2005, United, Delta, Northwest and US Airways filed for Chapter 11 Bankruptcy Reorganization.

The restructuring that took place over the decade improved productivity, fuel efficiency and reduced accident rates while passengers increased by a billion more people and 16 million more tonnes of cargo was moved. (source)

However, the restructuring among the airlines as well as an influx of passengers has not entirely improved the underlying business of the airlines or made them safe investments.

As Osborne notes, there’s a lot that can go wrong since the airline industry is highly competitive while ticket prices must also increase with the cost of fuel, which responds to a myriad of different disturbances.

We’ve taken a different cut at the airline stocks by looking at 10 years of financial statements for US Airways, JetBlue and Southwest Airlines and uncovered disappointing financials that have not improved over the years.

If you’re looking at airline stocks, we hope that this will be a good starting point for your analysis.

US Airways (LCC)

A look at US Airways’ fundamentals has shown that they have historically been disappointing. Its financial strength remains weak as shown in their balance sheets where TL-to-TA has hovered around 0.88 – 1.75 since 2001. They have also found it difficult to retain its profits while positive free cash flow has been virtually non-existent up until 2009.

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According to its Growth Price (FCF), LCC is currently undervalued by 375.90%. If LCC can turn it around, then the current price is of great value. But, given its track record, this is unlikely.

See Our LCC Stock Report Here

JetBlue Airways (JBLU)

On Tuesday, the share price of JetBlue traded at half the annual highs recorded in November 2010 while its stock became the most shorted in its industry. (source) A look at their financials over the last 10 years shows that these sentiments are well founded.

Highly capital intensive, poor management of cash as well as a weak balance sheet have been notable features of the company since 2001. Moreover, JetBlue has had the most difficulty of all three airlines in maintaining acceptable net profit margins (2.57% in 2010).

On the bright side, JetBlue has been reinvesting its profits, which may put it in a stronger position in the future. In 2010, its retained earnings grew by 85.29%.

See Our JBLU Stock Report Here

Southwest Airlines (LUV)

Southwest Airlines appears to be the best of a bad lot. It has withstood industry-wide consolidation, rejected bag fees and stood their ground against the gyrations of fuel prices while continuing to make a profit. (source) This company culture has allowed it to maintain a better competitive advantage than the above two airlines.

While it must suffer like the rest of them, Southwest has been able to maintain better net profit margins than the other two airlines. It also shows a relatively stronger balance sheet and has been able to consistently reinvest profits. Southwest also has a strong dividend history and shows brief instances of stock buybacks.