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Tuesday, September 25, 2007

Value in Growth at Lam Research and Verigy Inc.

Someone with a large position in Warren Buffett’s Berkshire Hathaway (ticker BRKA) asked if he should buy another cash loaded company with similar valuation metrics, Wesco Financial Corp. (WSC). My reply was the real value today is in some small capitalization technology stocks like Lam Research (LRCX) and Verigy (VRGY.) Here is my reasoning.

One of the reasons I have stayed away from Berkshire Hathaway is its “Warren E. Buffett Premium.” This is what people pay to own BRKA over “fair value” so Warren Buffett can manage their money. What happens to the price of BRKA if Buffett dies?

BRKA today reminds me of General Electric (GE) in 2000 when it still had its "Jack Welch Premium" not to mention the daily gushing on CNBC about how much money the reporters were making in the individual stock they could own. In 2000 GE had a PEG (Price-to-earnings ratio divide by its 5-year growth rate) twice that of the S&P500. Today that premium is gone and GE at $41 is still down about 30% from its 2000 peak while the S&P500 is back to its 2000 peak. High premiums are risky.

Selling at $117,200 with $30,343 per share in cash, BRKA is 26% cash. This survey of CD rates says you can get 5.0 to 5.75% at many banks in CDs. If I want to pay a premium for Warren Buffett to manage my money, then I would want his return on assets to beat safe CDs and treasuries enough to overcome this premium at a minimum.

Yahoo! finance lists BRKA’s “management effectiveness” as:

    Return on Assets (ttm): 4.65%
    Return on Equity (ttm): 11.34%
    (ttm is trailing twelve months)


With Valuation metrics:

    Trailing P/E (ttm, intraday) = 14.99
    Forward P/E (fye 31-Dec-08) = 19.35
    PEG Ratio (5 yr expected) = N/A (no earnings growth predicted)
    (fye is for year ending)


Why not put 25% of your money in 5.75% CDs and invest the other 75% in stocks with better GARP (Growth At Reasonable Price) metrics?

Compare the above numbers for BRKA to one of my larger holdings and a company I have already made about sixteen (16!) times my money on since buying it for my newsletter and personal portfolio in 1998, Lam Research (Ticker LRCX.)

Yahoo! finance lists Lam’s “management effectiveness” as:

    Return on Assets (ttm) = 21.21%
    Return on Equity (ttm): 43.29%

With valuation metrics:

    Trailing P/E (ttm, intraday)= 12.24
    Forward P/E (fye 25-Jun-08) = 12.21
    PEG Ratio (5 yr expected) = 0.65

Verigy is another “GARP” stock I have been buying for my newsletter portfolio and myself. Yahoo! finance lists Verigy’s “management effectiveness” as:

    Return on Assets (ttm): 10.38%
    Return on Equity (ttm): 18.48%

With valuation metrics:

    Trailing P/E (ttm, intraday)= 19.96
    Forward P/E (fye 31-Oct-08) = 13.47
    PEG Ratio (5 yr expected) = 0.79

Verigy has a similar cash/share ratio as BRKA but it makes far better returns overall.

I think there is great value now is in technology stocks that are not in the headlines. Everyone knows about Google (GOOG) and Apple (AAPL) but how many have heard of Lam Research or Verigy? The way to make big gains is to buy well managed growth stocks before everyone has heard of them. I have made good money already in both Lam and Verigy but I think there is much more to be made.

In addition, how are people trying to help third world countries improve? Are they giving them cans of Coke (KO) Geico insurance, Sees candy and Gillette razors (PG,) all subsidies of BRKA, or are they giving the kids portable, cheap, laptops with wireless connectivity that operate on the sun or hand cranking? Lam and Verigy are two of my best-valued stocks that make picks and shovels that help make this new technology possible.

BRKA is mostly a perceived "value stock" and we have had about 7 years where investors have shunned growth to buy good, safe value stocks. The numbers I posted above for Lam and Verigy, stocks I buy and sell for added return around a core position, show why I think a rotation to growth with value should occur soon, if it has not already started.

Subscribe now and get my just released October 2007 Newsletter with my two core portfolios plus my more volatile (and higher long term return) explore portfolio with the latest buy and sell targets.

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