COMMENTARY | COLUMNISTS | BRENT WILSEY

Know what a company does before investing in it

Companies are starting to post their quarterly earnings, and so far I’m pretty happy about what I’m reading.

Keep in mind that it's early in earning season, but I was a little worried that the election and the "fiscal cliff" concerns froze consumers and businesses alike. What I’ve seen so far does not show many signs of a problem.

Growth wasn't big in the fourth quarter, but there also wasn't a pullback like I was prepared for. Time will tell, but I’ll be watching and will keep you posted through many of my media outlets — stay tuned.

I’m receiving many requests for companies that readers want me to review. Thank you for your requests; I will try to do as many as I can.

I received a request from Mark about a company called PolyOne Corp (NYSE: POL). I always recommend to investors that they understand what a business does when they weigh whether to invest in it. That was kind of hard with this company because I didn’t understand what Polymer materials are, which is what this company provides, along with services and solutions with operations in special polymer formulations.

A polymer is a chemical compound or mixture of compounds consisting of repeating structural units created through a process of polymerization. Trying not to turn this investment column into a chemistry class, in short, polymerization is a process of reacting monomer molecules together in a chemical reaction to form chains, or three-dimensional networks.

I hope you get the hint that this company has a complex product and if you are going to invest in this company, I would recommend a further understanding of what they do.

Looking at the company valuations, this company is not cheap, trading at 25 times earnings and 16.5 times December 2013 forward earnings per share (16.5 times earnings is my target sell multiple). I also noticed that backing out the intangible assets leaves investors with a negative equity position.

Sales did climb 4 percent year over year, which was better than the industry sales growth of 0.2 percent. However, earnings per share fell by 66 percent for PolyOne when the industry only declined by 11.5 percent.

The industry of chemicals in which this company competes has a debt to equity of 65 percent, which is not too bad. PolyOne has a debt to equity of 112 percent and remember that some of its equity is in intangible assets and could be written down if accounting test isn’t met on the value of those assets, which would raise the debt to equity even more.

Return on equity looked ok at 13.1 percent but it was still under the industry average of 18.7 percent. Profit margin for the company came in at 2.8 percent, well below the industry average of 6.2 percent.

Inventory does look good for the company, turning over 9.7 times over the last 12 months compared to the industry turnover rate of 6.1 times.

The company reports earnings on Jan. 28, so while investors may miss some, on the upside one will get a better look of what the company is doing. Also, analysts' estimates will extend out to December 2014, perhaps increasing the target sell price.

I also received a request from Joe in San Diego about Amazon (Nasdaq: AMZN). I have written about this company before and the stock still continues to climb. Why? I don’t know. The stock has a current PE of 3,594 and a forward PE of 155 based on December 2013 earnings per share of $1.74. Yes, you read that right, investors are paying $270 for a company only earning $1.74.

I thought maybe the company has a good PEG ratio, which tells investors how much they are paying for the future growth of the company — the lower the PEG ratio the better. The PEG ratio for Amazon is -274.98, which is not a good PEG ratio.

All the valuations for Amazon are well above the industry average including price to sales, the leanest of the four ratios coming in at 2.1 vs. the industry at 0.60.

Year-over-year sales did climb 31.3 percent, well above the industry average of 6.5 percent. However, none of that sales growth made it to the bottom line as the company experienced a year-over-year earnings decline of 96 percent compared to the industry decline of 5 percent.

The company has a net profit margin of 0.3 percent versus the industry average of 2.7 percent; a return on equity of 0.5 percent, well below the industry average of 16.2 percent.

It looks like Amazon will report its fourth-quarter earnings Jan. 29 and I’m curious what will be said to keep investors drinking the Kool-Aid. The company missed its September 2012 estimated loss of 8 cents per share, coming in with a 60-cents-per-share loss.

If I held this company in my portfolio I would be worried it could have the same fate as Chipotle stock, where the stock price kept increasing to the nosebleed level, only to fall nearly 40 percent since last April.

I’m confident this company will follow the same path, I just can’t tell you when.

This is why some say the stock market is risky, because of crazy stock valuations on the Amazons and Chipotles of the world. But stocks are not risky if one doesn’t take undue risk.

I think investors are playing a dangerous game of musical chairs with this stock and many unfortunately will be left holding the bag.

If you have a public company that you would like to see written about send me an email at my website, Smartinvesting2000.com and I’ll try my best to write about it.

Have a question or a company you'd like me to take a look at? Email me at brent@wilseyassetmanagement.com.



Wilsey is president of Wilsey Asset Management and can be heard every Saturday at 8 a.m. on KFMB AM760. Information is provided by Reuters.

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