“Most Undervalued Stock of the S&P 500” Bottarelli Small Cap

by Travis Johnson, Stock Gumshoe | May 7, 2008 8:52 pm

OK, so that headline is a little bit deceiving — the ad is for Bottarelli[1] Research Small Cap, and much of it was indeed about what they thought was the most undervalued stock in the S&P 500. But they also told us directly what it was.

So we know that Bryan Bottarelli[2] thinks that Titanium Metals is the most undervalued stock in the big cap index — this email came in late last week, and at the time the shares were at 13 and change … they’ve since jumped up by a couple dollars to near $15, on relatively good earnings news (though keep it in perspective, the shares were near $50 when Jim Cramer was yelling about them every day and they were universally beloved a couple years ago).

But he also said he had two other good ideas for us in the ad, so let’s figger out what those might be.

Bottarelli, by the way, has been covered four times in this space — two stinkers (BCTE and DNDN) and two pretty good picks (WWAT and BCTE), at least as far as the prices so far indicate. I have no idea how he feels about any of those today, most of those teaser picks were many months ago.

Here’s the little section of clues for the first of our new ideas, here:

“The second niche sector I’m bullish on comes in the form of “Telecom Carrier Transferal Technology.” You see, the incredible competition between telecom carriers means that customers are now transferring from one service provider to the next with a frequency that’s never been seen before. You probably don’t even realize it, but one company (who just got the exclusive contract to handle all of the iPhone transfers) seamlessly switches tens of thousands of customers from one service to the next – giving birth to an entire new market niche in the beginning stages of growth. This transferal technology is absolutely critical to the entire telecom industry, making the one company with the exclusive iPhone contract another active recommendation in the Bottarelli Research[3] Small Cap ledger.”

Well, this is a piece of bad news that severely undercuts what sounded like a good idea in Titanium Metals — this one pretty well has to be …

Synchronoss (SNCR[4])

Synchronoss has been a favorite “iPhone play” by many advisors and newsletters over the past year, but the shares today fell about 40% based on fears that upcoming non-exclusive iPhone contracts and other hiccups might significantly hurt their business — weak forecast, lots of analyst downgrades, etc. The shares are now back down to around where they were in January of 2007 before the iPhone was even officially announced (I think I’m remembering that date properly).

SNCR certainly has plenty of other business and many other customers, but I have no idea how profitable it is, or how much growth is likely. It’s a well-covered company, especially for one so small (it’s under a half-billion in market cap after today’s haircut), so you can probably find plenty of thought on both sides of this one — be careful checking numbers in Yahoo[5] Finance or the like, those forward PE ratios likely won’t be up to date with new, downgraded earnings projections for a little while. I certainly wouldn’t assume that the forward PE that’s currently showing of about 11 is an exciting reason to buy.

What else is Bottarelli urging us to buy?

“And the third niche sector I’m bullish on is the ‘Growth of Successful U.S. Internet Business Models into Emerging Countries.’ As the world’s top emerging countries gain Internet access at exponential rates, you have a powerful investment situation to own the companies emulating the success of eBay, Amazon.com, or Google. That’s why another current Bottarelli Research Small Cap[6] recommendation is a company I call ‘The eBay/Google/Amazon of Latin America.’ I firmly believe this company should be in your portfolio as well.”

Well, we probably don’t need any more detail or confirmation to get this one with near certainty — the Thinkolator quickly opines that this one is …

Mercadolibre (MELI)

“eBay/Amazon of Latin America” seems a fair description to me — I wouldn’t throw Google into that, And Amazon is perhaps questionable. Mercadolibre is essentially an online marketplace, not unlike Amazon or eBay, and it does have a great growth profile and good penetration throughout Latin America. When you hear folks talking about “emerging markets” that are building homegrown online marketplaces, the best examples that you almost always hear will be Gmarket in South Korea[7] and Mercadolibre, which is based in Argentina[8] but hits most of the big South and Central American markets.

The strength of this one has the potential to be similar to the strength of eBay, since they also have an integrated payments solution (kind of like PayPal), and they have the potential to develop the kind of market penetration that develops a real network effect — with networks like this the key is to get biggest fastest, and they seem to be doing pretty well at that. One might assume that eBay could come in and crush them if they wanted, since they’re much larger, but that hasn’t worked in South Korea, or in China[9], or Japan[10], where other companies built critical mass better and quicker. Auction sites that utilize this network effect really give a huge first mover advantage, as long as that first mover does a good job — once someone gets a lot of buyers online, that’s where the sellers go. And once the sellers start going there, the buyers have no reason to go anywhere else. It builds on itself.

That said, my suspicion that Mercadolibre will continue to be a successful business doesn’t necessarily mean that their stock is great to buy right now — that’s your call, of course. The company is far from cheap, as you might imagine. The analysts put their PEG ratio at about 2, which is fairly high, though they might be underestimating the growth (earning growth has been massive of late, even better than revenue growth, which is what I like to see). But still, the trailing PE is well over 200 and the forward PE is in the 60s, so growth really does need to show up.

In terms of operating results, Mercadolibre has better performance stats than eBay, in general — profit margins and operating margins, and return on equity, are certainly more positive for MELI than for EBAY, but they’re also in a very different point in their development (EBAY is a $40 billion company, MELI is $2.5 billion). The only caution I would share is the long term price chart for EBAY — give it a look at any finance site and note that eBay had a huge move when it first went public in the late 90s during internet mania, getting right up to $20 (split adjusted) … it took almost another ten years to get to $30, with lots of ups and downs inbetween. If that’s going to be typical for this kind of company, it might be good to get an idea in your head about where in that development you think MELI is — do they still have the huge move as they build? Or have we missed some or all of that move?

And it’s an Argentinian company that does business in Brazil[11], Mexico[12], and other big markets to the south — so pay attention to those economies, particularly the consumer economies and the spread of credit cards and internet access, and the currencies of the countries they operate in, most of which are at long-time highs against the dollar (doesn’t mean they’ll go down, but it does mean they’ve already gone up a lot). Both of those themes will also be important to this stock’s future.

Even a great company with a huge network effect and a sustainable competitive advantage can disappoint, make dumb decisions, and/or be very volatile. I don’t have anything bad to say about MELI, but the valuation certainly makes me cautious. The price looks better today at $56 than it did at $80 a few months ago, but it’s still a rich price to go with the expected crazy growth rates.

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