(By Barry Randall) It's time to start looking ahead to 2013, so this month we're using a Q&A format for our monthly investor letter.
What is our outlook for 2013?
Here at Crabtree Asset Management, our outlook for 2013 is quite positive. Relatively low energy prices, generationally low mortgage rates, improving unemployment in the United States, and record-high corporate profit levels create a launching pad for stock prices in general.
In technology in particular, the continued maturation and underperformance of tech war horses like Microsoft (MSFT), Nokia (NOK), Dell (DELL), Hewlett-Packard (HPQ), Research in Motion (RIMM), and the recent swoon of Apple (AAPL) means there are even fewer investible large-capitalization stocks into which existing and new investment money can flow.
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We believe this means that technology will be a "stock-pickers" market in 2013, with a premium on choosing the right names early in the year.
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What are our two favorite stocks for 2013 and why?
Regular followers of Crabtree Asset Management know that we love IBM for their brilliant business model of "manufacturing earnings." So we won't revisit that here. But among the other 49 stocks in the Crabtree Technology model, we'd like to single out the following pair.
NIC Inc. (EGOV) NIC is an IT services firm that specializes in creating and running governmental web sites. In particular, 26 of the 50 U.S. states employ NIC to run their state web sites. These sites are used by residents and businesses to handle a variety of activities, including (but not limited to):
- Access to driver records;
- Renewing a driver's license;
- Renewing a vehicle registration;
- Pay a speeding/parking ticket;
- Reserve space/services at a state park;
- Applying for a permit (hunting, fishing, etc.)
- Providing/renewing documentation related to election laws;
- Filing and paying taxes;
- File a court document;
- Doing criminal history searches;
- Searching for registered sex offenders;
- Registering/incorporating a new business.
Although NIC has grown its revenue and profits nicely in the past few years, we believe it still has a variety of levers it can pull to maintain growth, market share and profitability, including but not limited to:
- Add more U.S. States (NIC counts only Texas as a client among the 10 largest U.S. states);
- Add Federal government agencies (NIC is already running a Federal trucking database);
- Sell applications developed for one state to another state;
- Create new applications to sell to all states.
NIC consistently generates cash, meets Wall Street expectations, pays annual dividends and does all these things without drama.
eHealth, Inc. (EHTH) EHealth is a leading web-based provider of health insurance options for individuals and small businesses. The company's e-commerce platforms organize and present health insurance information in various formats and allow individuals, families, and small businesses to research, analyze, compare, and purchase various health insurance plans.
With the continued roll-out of the Affordable Care Act (i.e., "Obamacare"), independent marketplaces like eHealth can help individuals sort fact from fiction and will be more valuable than ever before. Moreover, eHealth will likely play a role in forming the new Health Care Exchanges mandated by the law. It's an under-the-radar Software-as-a-Service business with a small but growing market share.
What is our top sector investment for 2013 and why?
Since we focus on technology at Crabtree Asset Management, we'll rephrase that question as, "what's our favorite technology sub-sector?" Our answer is Software-as-a-Service. As you probably noticed, both our 2013 favorites, NIC and eHealth, are SaaS companies and we own several others in our Covestor Crabtree Technology model, including XOXO Group, CoStar Group, Demand Media and Stamps.com.
While the term Software-as-a-Service is fairly self-descriptive, it's perhaps more helpful to think of these companies as hybrids, combining elements of a traditional software company with an IT service company and a traditional utility. And because the internet has already been bought and paid for, utilizing it to deliver information is unusually cost-effective. That's unlikely to change in 2013, and we are continually on the lookout for additional SaaS investments.
What will be the top three technology stories in 2013?
1. We believe Google will come under more formal charges by U.S. antitrust authorities.
Both U.S. and European regulators have fielded a lot of complaints (mostly from Google competitors) about how Google allegedly favors its own services (e.g YouTube) in its search results. There are also concerns that Google has pressured makers of devices running Google's open source Android operating system to add or remove software elements that Google either doesn't support or for which they don't have strategic plans.
There are no major smoking guns, however and having Google formally charged with some offense, real or imagined, is mostly about the bureaucratic process grinding its wheels, rather than offering truth and justice. So while the expected headlines may seem dire, the reality for Google and its very happy users will probably be business-as-usual, in our opinion.
2. We believe Groupon will declare bankruptcy.
Of course, this is misleading on several levels, starting with the fact that Groupon (GRPN) isn't even a technology company. It's a marketing services firm. And bankruptcy will hardly be a shock to Groupon's business model, which we believe has always existed in a fairyland of high-marketing-spend, high-revenue-growth and up-front-payments disguising rot at the core. All you need to know is that in its most recent four quarters of business, Groupon's quarterly cash flows have been $879 million, $38 million, $25 million and $15 million. We don't think you need a Wall Street analyst to tell you how this is going to end.
3. We believe Steve Ballmer will step down as Microsoft CEO.
In the last 10 years, Microsoft (MSFT) has spent $79 billion on research and development. And can anyone name a new, profitable business Microsoft has entered in that time frame? Meanwhile, Windows 8 has been underwhelming to say the least. It's time. Maybe they'll shock the world by buying Yahoo. Oh wait, they already tried that once.
What will be the single-most crowded investment at the start of 2013?
Our opinion: Apple. According to Nasdaq, Apple remained the stock most widely held by institutions as of the end of September 2012 - more than AT&T, Exxon, Wal-Mart and Microsoft. And only 66 institutions exited their Apple positions completely during the third quarter, leaving 1,949 others to endure "Mr. Cook's Wild Ride" as Apple dropped 25 percent from its September 19th high.
But given Apple's 10-year-long winning streak, it seems likely that many investors will interpret Apple's price pullback as a buying opportunity. Of course, only the future will reveal whether buying Apple now is a good idea. But one thing bargain hunters may want to consider is that, all things being equal, at least one study shows broadly recognized stocks underperform less-well-known stocks to the point where stocks with no media coverage outperform stocks with high media coverage by three percent per year after controlling for commonly recognized risk factors.
Of course, this is just a statistical average. And Apple has defied skeptics, famously, for over a decade.
Meanwhile, November performance for the Crabtree Technology model was slightly disappointing, at least in comparison to our benchmarks. The model declined by 2.6% in November. By comparison to our Covestor benchmarks, the Nasdaq 100 rose 4.3%, and the S&P 500 declined by 1.7%. There were no major ‘blow-ups' in the model as we completed the third quarter earnings season.
So we attributed the result simply to the systemic risk inherent in a portfolio of relatively small-cap growth stocks.
In short, steady as she goes. In our post next month, we'll discuss the results of our fourth quarter portfolio rebalance, including which stocks were sold or trimmed and which new ones were added.
Performance discussed is net of advisory fees, and includes reinvestment of dividends or other earnings.Past performance is no guarantee of future results.
The investments discussed are held in client accounts as of 11/30/12. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.
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