The Valuation Game

As far as I am concerned, the price-to-earnings ratio (P/E) is the least relevant metric; interestingly, it is the one that market analysts rely on most. Individual financial ratios are of little use without the context of profit margins. I am always suspect of low P/E companies with higher price-to-sales (P/S) ratios. (The P/S ratio is the stock's capitalization divided by its sales over a 12-month period.) This indicates that profit margins are very high. That is generally a good thing, but if you can't find supporting evidence that this is sustainable longer term, the P/E ratio can inflate pretty quickly as margins return to more traditional industry levels.

RIMM trades at unfavorably large premiums to its peers on all metrics, but most significantly the P/S ratio. This is disconcerting especially at this stage of maturity. This is not a small company; the market valuation is already $25 billion. If you ex-out Motorola's net cash position, RIMM is already more than two-thirds the size with one-tenth the revenue.

Sure, Motorola has a more diversified product line, and some of the products have lower or nonexistent margins; some analysts might look at that as a positive. Those additional revenue sources would provide a nice cushion should one of your products, say a smartphone, start to face increased competition and decreased margins.

I don't know why anyone would pay this type of premium for any company, especially one like RIMM, which is already facing the headwinds of the finite nature of growth and market size. If RIMM's product margins fall back to reality, and there is no reason they shouldn't, we can assume a generous P/S of 2 times revenues and a stock price closer to $60, less than half of its current trading price of about $135. Who wants to own stock in RIMM if that happens?

Not me.

Stem Cells Are KOOL

Let's establish that I have an aversion to large-caps. I don't like my gains to be limited to a double. The notion that risk is diminished buying established large-caps is nonsense. Tell that to all the grannies holding on to AT&T (T Quote), Lucent (ALU Quote) and Pfizer (PFE Quote). When there is a lot baked in the cake already, often there isn't anywhere to go but down. Really, if everyone already owns the stock, where is the new money to drive it higher supposed to come from? You want to buy Microsoft (MSFT Quote) here as a growth stock? Go ahead, but it already looks pretty grown to me.

As an alternative, how about a nice little company exposed to a hot new growth area with a great balance sheet, big growth, visible profitability and a minuscule market cap? Thermogenesis, active in stem cell research, fits the bill. Microsoft could buy the company with about a month's interest earned on its cash hoard.

Stem cell research is a hot topic right now. With the Democrats on the verge of significantly more influence, stem cells should only get hotter and more interesting. If we can separate church and state in 2007, the U.S. can regain its stronghold on scientific innovation. My scientific sources believe stem cell research will yield positive results. This stuff works; we just don't know how to use it yet.

Like any other new technology, it is difficult to pick the winners early on. Rather than betting on which company is going to be first to a fantastic discovery, I prefer to bet on enablers or tool providers that should benefit regardless. I have already highlighted Viacell (VIAC Quote), a stem cell therapy research company that also offers collection and banking of umbilical cord blood through subsidiary Viacord, as one company that should benefit. Thermogenesis is another: a provider of tools necessary to isolate, collect and preserve stem cells.