Whether most investors realize it or not, it is an indisputable fact that the stock market (a.k.a Mr. Market) is not always rational. Sometimes an individual stock can be extremely overpriced or extremely underpriced at any moment in time. And, of course there are times when the market is behaving rational and the stock price is where it should be. However, my point is to not count on the market behaving rationally, it could be a very unprofitable position to take.
The legendary Ben Graham gave us his famous Mr. Market metaphor as follows:
“Imagine you are partners in a private business with a man named Mr. Market. Each day, he comes to your office or home and offers to buy your interest in the company or sell you his [the choice is yours]. The catch is, Mr. Market is an emotional wreck. At times, he suffers from excessive highs and at others, suicidal lows. When he is on one of his manic highs, his offering price for the business is high as well, because everything in his world at the time is cheery. His outlook for the company is wonderful, so he is only willing to sell you his stake in the company at a premium. At other times, his mood goes south and all he sees is a dismal future for the company. In fact, he is so concerned, he is willing to sell you his part of the company for far less than it is worth. All the while, the underlying value of the company may not have changed – just Mr. Market’s mood.”
This may be one of the most intelligent market metaphors that were ever made. A current case in point would be Green Mountain Coffee Roasters (GMCR). By the summer of 2011, Mr. Market was literally giddy over Green Mountain Coffee Roasters and priced the stock significantly above fair value. Today, less than a year, Mr. Market’s mood about Green Mountain Coffee Roasters has gone dark and share price has plummeted. Yet, very little regarding the company’s business and its prospects for growth has changed. The most recent earnings report was actually good, the future guidance cut mere pennies off of their previous guidance, and the stock fell over 45 percent in one day.
When looked at through the lens of F.A.S.T. Graphs™ (Fundamentals Analyzer Software Tool), we see a vivid depiction of Ben Graham’s famous metaphor graphically illustrated. The orange line on the graph represents intrinsic value based on earnings. The graph has been adjusted based on the guidance presented by Green Mountain Coffee Roasters’ management during their most recent quarterly report. The blue line represents the normal price earnings ratio that Mr. Market has applied to the stock historically, and the black line represents monthly closing stock prices.
Therefore, we feel it should be clear that although little has changed with the company’s business, the stock price has been extremely volatile going from extreme overvaluation to what now appears to be extreme undervaluation. Put another way, the PE ratio has gone from the 60s to the current PE ratio of 11.6, which is approximately 1/5 of its all-time high. Meanwhile, earnings per share have continued advancing at a very rapid rate.
Although the leading analysts following Green Mountain Coffee Roasters forecast earnings growth to slow from its historical average, consensus still expects future growth to be in excess of 30% per annum. Therefore, a strong case could be made that Green Mountain Coffee Roasters represents an extraordinary value at today’s levels. Of course, this assumes that the consensus earnings estimates turn out to be correct, or at least correct within reason.
Summary and Conclusions
The stock price of Green Mountain Coffee Roasters has been on a major roller coaster ride over the last couple of years. On the other hand, the business has remained strong. Earnings have been good, and the company has a strong balance sheet. Therefore, aggressive investors seeking maximum capital appreciation might want to take a closer look at this quintessential example of a pure unadulterated growth stock. As always, we recommend you conduct your own thorough due dilligence.
Disclosure: Long GMCR at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.