Skip to main content

The Real Story: Getting Into Netgear

Investors shouldn't wait for the 'all clear' signal from this networking equipment maker.

Show me, show me
Give me just one sign

-- ABC

There are some stocks, such as

BJ's Wholesale Club


, that I consider "show me" stocks. Things are

not going right and management needs to prove that conditions are changing for the better before I'll get behind the stock.

Then there are stocks like



. Investors who wait for Netgear to prove that its recent troubles are a thing of the past are likely to miss out on some significant gains.

The Consensus Story

: Netgear ran into some inventory problems over the past two quarters, resulting in disappointing earnings. Wall Street remains unconvinced that the issues are behind the company. Additionally, there is skepticism that some of Netgear's new products will gain enough traction to fuel meaningful growth.

The Real Story

: The inventory issues were a hiccup for what has been a solid management team. Based on the track record, management gets the benefit of the doubt in my book. Netgear's products routinely get good reviews and often significantly outperform the competition. The company's earnings, revenue and margins are growing, and should accelerate in 2007. According to Gartner, 13 million homes have a wireless network, but 32 million have more than one computer. Management expects its markets to grow 15% to 20% per year. The stock trades at 15 times the consensus 2007 earnings estimate, which I believe is too low.

The first half of the year is typically slower than the second half for Netgear. I believe the stock can get back to its previous all-time high level at around $25 should the company come out with positive developments in the first half or report strong sales in the last six months of the year.

The Stats

The 2006 First Call consensus EPS estimate of $1.12 represents 8% growth on revenue growth of just 4%. If the consensus is on the money in 2007, Netgear's earnings will grow 14% to $1.28 on sales growth of 9%. Margins are expected to increase in both years as well. Should analysts' top-line estimates prove conservative, Netgear could report a nice upside EPS surprise.

Scroll to Continue

TheStreet Recommends

My model assumes conditions won't be as dour as the consensus. I'm targeting 2006 EPS at $1.16 and 2007 EPS at $1.34.

Even using Wall Street's more cautious estimate, the stock is trading at only 17 times 2006 earnings and 15 times 2007 earnings. The price-to-sales ratio is also low, at 1.2 times 2006 sales and 1.1 times 2007's estimate.

Netgear has a sparkling balance sheet with no debt, $90 million in cash and it is cash-flow positive. Nevertheless, the stock has also been targeted by shorts: 5.3 million shares were sold short as of March 10. Over 13% of the float is sold short. Short interest spiked in January and is now at its highest level since September, when the stock reached its all-time high. The high short interest is not only a good gauge of sentiment, but could spark some buying activity if the stock rises and forces the shorts to cover.

The Need for Speed

Netgear makes routers, switches, Ethernet bridges and other networking products for homes and small businesses. In March,

PC Magazine

said Netgear's RangeMax 240 was the first wireless router to break the 100 Mbps (megabits per second) barrier in its labs. The router outperformed rival

Cisco Systems'


Linksys Wireless-G Broadband Router. The review concluded: "If you're streaming multimedia to several wireless clients or engage in other bandwidth-hogging pursuits, this is the best router currently available."

Netgear also recently received an Editor's Choice Award from

IT Magazine

for two of its stackable smart switches.

Netgear has a history of being first to market with innovative products before the technologies become commoditized and fall in price. The company was among the first to announce routers on the new 802.11n standard. The 802.11n routers are expected to be significantly faster than existing wireless models. Netgear also has a low-cost manufacturing structure, which keeps margins healthy.

Inventory Problems

If you have to have inventory problems, then Netgear's are the kind you want. It wasn't that boxes were sitting on the shelves getting old, but that Netgear couldn't match demand for several of its products.

Friess Associates is the largest institutional holder of Netgear stock, with 1.6 million shares as of Dec. 31. Friess Chief Investment Officer Bill D'Alonzo believes inventory won't cause difficulties in the first quarter (Netgear reports first-quarter earnings after the market closes April 26). "The Netgear management team is smart and capable with solid long-term vision," he says. "We think Netgear got enough inventory into the channel early this year to make a March-quarter disappointment unlikely."

Most sell-side analysts are taking a wait-and-see approach. There are currently four buys, nine holds and one sell rating on the stock, according to Thomson/First Call. Last week, D.A. Davidson & Co.'s Aalok Shah wrote: "We believe the problem extends beyond the ability to forecast adequate demand. We believe pricing pressures and the lack of new compelling products may also be limiting the near-term for Netgear." Shah has a neutral rating on the stock, and D.A. Davidson expects to receive or intends to seek compensation for investment banking services from Netgear in the next three months.

I suspect this kind of thinking is too cautious. Netgear has always operated in a tough pricing environment and has proven itself over the years. Additionally, the company's new Skype phones and 802.11n routers should garner a lot of media attention when they are introduced, which should help boost sales.

Freiss Associates' D'Alonzo agrees. "One of the risks, of course, is being early, but our trade checks with customers bolster our confidence about timing."

In investing, timing is everything. Those who wait for "just one sign" could see this stock get away from them before they have the opportunity to buy.

In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86,87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback;

click here

to send him an email.