New Price Target

This is the really fun part of a bull market. Analysts are starting to raise price targets on stocks because… well, because the stock price just beat the old target, and the price is clearly still going up, so a new, higher target is needed… we’ll fill in the blanks for justification later.

Case in point: Apple (NASDAQ: AAPL). Apple gets an upgrade today from KeyBanc. The analyst says a “more aggressive market segmentation strategy… seems likely to increase gross profit per user and drive gross margin higher.”

So, let’s translate that into actual English. What the analyst is saying is simply that gross profit margins for Apple could go higher. Um, well, yeah — if you raise the price of the latest iPhone from $799 to $999, your gross profit better go up…

Please notice that there’s no mention of how many phones Apple will sell. Or what net income will be. Or how much cash will get put in the bank. It’s just gross margins. Gross margins are just sales minus costs. You can have great gross margins because the product is hot, but crappy net profit because management stinks.

Now, we know Apple is very good at controlling costs, but still. And besides that, gross margins are fairly easy to manipulate. Maybe that’s worth a new price target of $187…

The analysts at Needham still say Nvidia is a buy. But after the stock closed at $191 last Thursday, it was obviously just a matter of days before it beat the old price target of $200. So, upping the price target to $250 was the only logical thing to do. That’s a 25% price hike on a stock that’s run from $65 to $190 over the last year.

Now, to be fair, earnings estimates for next year have gone up, from $3.51 to $4.02. That’s 14%. And Nvidia currently trades at 48 times forward earnings (a forward P/E of 48). At $250, Nvidia would have a forward P/E of around 60…

This reminds me of that classic scene from Spinal Tap, where Nigel Tufnel keeps pointing out that his amp goes to 11…

Q: Yes, Nvidia is growing very well, but are you worried that investors are paying too much for those earnings?

A: But this stock goes to $250.

Again, I’ve got no axe to grind with Nvidia. The company is in a very sweet spot. But I take notice when price targets start getting hiked on stocks that have already had a massive run…

How High Can You Go? 

Like Micron Tech (NASDAQ: MU). First it was $35, then $40, then $50. Now Barclays says $60, with the analyst noting, “Things still seem different this time.”

Oh boy. Really? Why would any analyst want to challenge the stock price gods by invoking the four most dreaded words in investing, “It’s Different This Time“? 

Like Apple and Nvidia, Micron has had a great run. As the biggest flash memory maker, Micron has been perfectly positioned to capitalize on flash demand from cell phones and laptops. But I would point out that flash is especially cyclical because it’s not as difficult to make as other chips. When prices get strong enough, other players tend to enter the market. Maybe that’s why revenue is forecast to fall to $24.59 billion next year from $24.67 billion this year.

Yeah, that’s not a big decline. But if there’s no growth, why raise the price target? 

Well, I can tell you that Micron, for one, isn’t arguing. Right about the time that price target went to $50, Micron announced it was offering up $1 billion worth of stock to raise cash. Now, when times are good, you should pay down debt. And Micron has ~$9 billion in long-term debt. But repeat after me: buy low, sell high. 

It’s true that companies aren’t experts on timing. It doesn’t mark a bottom when they buy, and it doesn’t mark a top when they sell. Nevertheless, you gotta think management thinks the current stock price is pretty good. 

Did you see that Netflix raised its prices a couple weeks ago? Well, last week, JP Morgan raised its price target for Netflix to $220 a share. Not to be outdone, Goldman went to $235. It’s like a bidding war to see who can be the most bullish. 

Now, once again, Netflix’s business is doing very, very well. Earnings are up something like 180% over the last year. It’s got 104 million customers as of the end of the second quarter. Current numbers are probably around 110 million. Analysts think Netflix will hit $11.45 billion in revenue in 2017 and $14.2 billion in 2018. It should make a little over $900 million in profit next year. 

Now for the “but.” That growth comes at a high cost. Specifically, $6 billion this year and $7 billion next year in content costs. Yeah, that’s roughly 50% of revenue just for content. For comparison’s sake, Amazon will spend around $4 billion, and HBO around $2.5 billion. So, Netflix is paying a lot. And it’s getting a lot. What about investors, are they (we) getting a lot?

The Growth Problem

Right now, Netflix has a market cap of $85 billion. That’s about 7.5 times revenue. In other words, kind of a lot. But it’s nothing compared to earnings. Netflix trades at 241 times trailing 12-month earnings and 93 times forward earnings.

So, if the stock stays right where it is, it will be attractively valued in about two years. That’s the beauty of growing earnings 77% a year. The company can grow into its valuations pretty quickly if only investors could wait…

Now, maybe you noticed that all the companies here (and I didn’t mention the $1,350 target for Google, from $1,100) are tech companies. Tech tends to get more price target fluctuations because the businesses tend to be harder to predict. Of course, that cuts both ways. When growth is booming, it’s like the growth rates will never change. Analysts can only look at past and current results to make their guesses about the future. And in that context, they do pretty well…

But who’s to say those growth rates actually do hold for the next quarters and years? Growth rates are often projected five years out. That is insane. Things happen fast. Nokia went from selling 100 million phones with its Symbian OS in 2010 to 40 million in 2012. 

Netflix has a lot of competition, including current partner Disney, which will start its own streaming service next year. Google just paid the biggest fine in history for placing its own ads more advantageously than the competition’s in search results. Right now, analysts are simply ignoring the potential for new regulations on Google or a threat to Nvidia’s graphics card business from AMD. 

One thing is certain: stuff will continue to happen fast in tech stocks. I learned this business during the internet bubble. It’s very similar today, except that the wildly bullish sentiment is concentrated in fewer companies. Growth is great right now, but don’t be blinded: that will change at some point.

Until next time,

Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.