CWS Market Review – August 31, 2021

(This is the free version of CWS Market Review. If you like what you see, then please sign up for the premium newsletter for $20 per month or $200 for the whole year.)

What Makes a Stock a Good Value?

In late 2019, I was strongly considering adding Trex (TREX) to our Buy List. I really liked the business, but I was very concerned about the price.

I hate overpaying for any stock. After running all my calculations, I determined that $45 per share was a good price for Trex. If I could add it at $43 per share, well then that was very good. But if it climbed to $47 or higher, then I was apprehensive.

I stressed about this decision a lot. Ultimately, I added it to our Buy List at $44.94 per share. Here we are 20 months later and Trex is just over $109 per share. We have a 140% gain in just 20 months!

Trex has been a home run for us. In retrospect, why was I stressing so darned much? It seems silly that I was so concerned about a few dollars on a stock that was prepared to rally. Of course, I didn’t know that at the time.

This raises a good lesson for investors and it’s something I want to share with you in this issue. The question: What is a good value?

Conventionally, it means a stock with generous valuation metrics. It may have a high dividend yield or a low price-to-earnings ratio. But shouldn’t we concern ourselves with other factors? Perhaps the company’s ability to grow may be its most undervalued asset. If so, that changes the way we value businesses, and that’s what I want to get at this week.

I’ll give you an example. In late 1998, Wall Street was taking notice of these new-fangled Internet stocks. Shares of Amazon, in particular, were soaring to the moon. On October 9, 1998, Amazon closed at $86-3/16 (remember those fractions!). By mid-December, it got to $242-3/4 per share.

Then things really got crazy! Henry Blodget, a well-known analyst, gave Amazon a $400 price target. Wall Street went bonkers and Amazon jumped $46 per share that day. It took less than a month for Amazon to reach Blodget’s price target. In fact, it smashed through it. Amazon got over $550 per share in early January (these numbers are not adjusted for splits).

Obviously, this was a massive stock bubble. Right? Once the bubble burst, shares of Amazon plunged 95%.

Hold on a second. That’s only if you sold. But what if you didn’t? In the two decades since then, Amazon has grown fantastically. Viewed that way, Blodget’s price target was a bargain—a huge bargain. (Here’s an article I wrote on the 20th anniversary of Amazon’s IPO>)

If you had paid $3,000 for Amazon and held on to it to today, then you’d have made a huge profit and also outperformed the market by a good margin.

But remember those words I just wrote, “if you held on to it.” For the long-term investor, the stock market is always cheap.

A value investor is looking to get a cheap stock based on today’s valuation. Let’s say that you buy a stock at 10 times earnings that should be going for 20 times earnings. If that eventually adjusts within a year or two, that’s a great trade. But there’s a limit an investor can make when the earnings multiple regresses to the mean. Earnings, by contrast, can keep growing and growing.

For example, shares of Colgate-Palmolive currently yield 2.3%. That’s not bad. But if you had bought it 30 years ago, then it would now be yielding you 35% based on the original purchase price. This is what I talked about in last week’s issue, the importance of spotting a stock with a competitive advantage.

The lesson is to not get bogged down with the ratios. Just about every investor can do long division. You also have consider what the company is doing.

Stock Focus: Masimo Corporation (MASI)

Having said that, I want to talk about one of my favorite growth stocks and a stock with a definite competitive advantage, Masimo Corporation (MASI). Masimo is a medical technology company based in Irvine, CA. This is a fascinating company that’s not well-known but it’s a cool story. What I particularly like about Masimo is the role that it’s playing in combating the coronavirus.

Masimo was founded by Joe Kiani, an Iranian immigrant. Kiani came to the U.S. when he was only nine years old and he knew three words of English. Still, he graduated high school at 15 and by 22 he had a bachelor’s and master’s degree in electrical engineering. Kiani founded Masimo in 1989 when he was 25 years old.

Today, Masimo is a $15 billion enterprise. It employs 2,000 people and last year it had sales of $1.14 billion. Masimo is perhaps best known for its pulse oximetry. This is a noninvasive method for monitoring a person’s oxygen saturation. This is a great product with enormous potential.

Masimo has developed a SafetyNet device which is a disposable smart wristband with a pulse oximetry that’s taped around your finger. It monitors your vitals like your pulse and oxygen levels. If there’s a problem, an update is sent to your smart phone, and it alerts your doctor. It can also be connected to a central monitor like a hospital.

Each year, over 200 million patients are monitored with Masimo’s technology. Nine of the top ten hospitals rated by U.S. News primarily use their technology.

Did you know that unpredictable reactions to opioids kill more people than car crashes? It’s impossible to know who’s at risk. But with continuous monitoring, we can spot adverse reactions quickly.

Interestingly, the device was meant to be used for opioid addicts, but plans changed once the pandemic hit. Now it’s being used on coronavirus patients. Since the technology is wireless, it’s also safer for healthcare workers.

Tying back to my earlier point, Masimo has been a great growth stock. Consider these numbers. Masimo’s earnings-per-share rose from $2.28 in 2016 to $3.13 in 2017. Earnings then fell in 2018 to $3.03 per share but rebounded to $3.22 per share in 2019. Earnings then rose to $3.60 per share last year.

What about for this year? Masimo recently revised its guidance higher for 2021. Masimo now expects $3.85 per share for this year. That’s very doable. Masimo has already made $1.80 per share for the first half of the year.

I don’t think Wall Street fully understands the potential of Masimo. Only seven analysts follow it. The stock has beaten earnings for 28 consecutive quarters. The average beat has been more than 14%.

Thanks to the growing earnings, shares of Masimo have performed very well. Masimo IPO’d in 2007 at $17 and the shares are now at $271. The stock is up about 16-fold in 14 years.

There’s so much I like about this company. Here’s an interview Kiani did last year with Jim Cramer:

Interesting side note: Masimo has been in a big legal fight with Apple. Masimo claims that Apple poached their trade secrets for their Apple Watch. I should add that Kiani is no stranger to these kinds of legal battles, and he’s already won a few cases with big settlements. The odd thing with this one is Apple’s complete intransigence. Kiani said that Apple has also picked off some of Masimo’s top talent. I guess rules are a little different when you have a market cap of $2.5 trillion. Still, my money’s on Kiani in any courtroom.

One month ago, Masimo beat earnings again. For Q2, the company earned 94 cents per share. That topped the Street by four cents per share. I also like that its operating margin often runs around 22% to 24%.

Joe Kiani, Chairman and Chief Executive Officer of Masimo, said “We are happy to report strong second quarter results. While we expected the drivers and capital orders of 2021 to be lower than we achieved in 2020 due to high demand during the height of COVID-19, and expected sensor volumes to rebound as elective surgeries recover, we did not anticipate the very strong increase in single-patient-use sensors that we realized this quarter. This produced higher revenues that exceeded expectations for this period.”

I got excited earlier this year when shares of MASI tanked. The stock fell from $284 in January down to $205 by June. I love when stocks of companies I like get hammered. MASI has already made back nearly everything it lost.

Frankly, I’m not wild about MASI at $270, but if it gets back to $200 or so, then could be a very compelling buy. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

P.S. If you haven’t had a chance, you can subscribe to our premium newsletter. It’s only $20 a month or $200 a year. Please join us!