Somebody seriously should call Martha Stewart and give her a stock tip; tell her to sell her own stock. **Martha Stewart Living Omnimedia (MSO)** reported 2nd quarter numbers and the results do little to explain why the stock, at $28, is worth $1.43 billion.

Sales for the quarter were $46 million, broken down as follows: publishing (69%), merchandise sales (22%), internet sales (5%), and television programming (4%). Amazingly, MSO *lost $33 million* in the quarter, hardly a profitable business model. Even if you exclude items like equity compensation, and focus just on product costs as well as selling, general, and administrative expenses, MSO lost $11 million on $46 million sales.

Clearly investors are focused on the upcoming Apprentice show for added profitability. However, given that Martha’s current shows are contributing only 4% of sales, investors would be correct in asking how much the new NBC series could possibly materially add to earnings.

Can anyone out there please explain how this company is being valued at more than $1.4 billion? Until I can understand such a justification, I’d be betting against MSO shares.

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MSO’s projected next year growth in EPS is 120%. Their forward PE is 189.7.

GOOG’s projected next year growth in EPS is 31%. Their forward PE is 40.5.

If GOOG is fairly valued, then 40.5/31 = 1.31 is the multiple to use for EPS growth to allowable PE ratio.

MSO’s ratio is 1.58, suggesting it is slightly overvalued considering its growth.

Applying GOOG’s PE to Growth ratio to MSO gives a price target of $21.90 and a value of $1.1 bil.

Bill,

MSO is expected to lose money in 2005, as it did in both 2003 and 2004. Earnings for 2006 are expected to be $0.14 per share.

I’m not sure where you get MSO’s earnings growth rate of 120%. If you don’t have earnings to begin with, you can’t have earnings growth.

If you want to use a PEG ratio of 1.3 for MSO, that seems fair. MSO will grow revenue 30% in 2006, so a 1.3 PEG ratio gets you to a P/E of 39x. The $0.14 estimate times a 39x multiple get you a share price of $5.46 for MSO.

That said, I would argue that one should use sustainable growth rates when using a PEG ratio calculation. Many investors will use the estimated 3-5 year growth rate as opposed to a 1-year growth rate.

While Google’s 3-5 year estimated growth rate is 30% annually, MSO’s would be less than that.

http://finance.yahoo.com/q/ae?s=MSO

Tab down to “growth estimate.”

Anything “sexy” trades at ungodly multiples despite a lack of financial rationality. MSO and GOOG both fall into that category.

Most retail and many (if not most) professional investors are like that. The “finance 101” assumption that market participants are “rational” is easily disproved by the evidence. However, the irrational investor does get a non-economic benefit from purchasing a MSO, GOOG, or other “glamour” stock. They get to talk about their stocks at cocktail parties. This is the real reason they trade at high multiples.

No one wants to hear about how I made 20% by investing in the world’s 4th largest fertilizer company. Oh, but mention your holdings of Starbucks, Google, or Martha Stewart and watch them flock to you!

Just because Yahoo’s web site calculates earnings growth rates even when there are negative numbers involved, it doesn’t mean it’s the right calculation.

So, the computer took a 69 cent loss and a 14 cents profit, found the difference to be 83 cents, and then spit out that 83 cents is 120% of 69 cents.

All you have to do is look at the numbers and you can figure out that turning a 69 cent loss into a 14 cent gain is not considered 120% growth in earnings.

Your glamour example explains why MSO trades where it does, but comparing the valuations of GOOG, SBUX, and MSO is not a fair comparison. Using the same valuation metrics one a coffee shop, an Internet company, and a publishing/programming/merchandise company isn’t goign to work, as different businesses are valued in different ways. MSO doesn’t not have profits to back up its share price, whereas the other ones do. Still though, some people are betting MSO will get there in coming years.

Take $0.14 per share. Apply growth of earnings = 25% annually for 5 years. Growth thereafter reverts to the long-term S&P 500 average of 6% annually. Apply a discount factor of 8% (4.5% 10YT yield + 3% CPI). The DCF model then gives you a target price of $15.73.

If you change the assumed 2006 EPS to $0.20 (high end of estimate) you get $22.46 target price.

If you take the high end estimate for 2006 and assume 30% growth over the next 5 years, you get $27.21.

Currently it trades at $26.17.

A five-year growth rate of 25%-30% annually? How does a magazine company (70% of sales) grow that fast?

Over 90% of the firm’s sales come from magazine sales/ads and merchandise sales. Granted, the new Apprentice show might boost merch sales a decent amount.

If they can grow this company 3x as fast now than they could when Martha was in her hey-day, current shareholders deserve to make good money.

From 1997 through 2001, according to Reuters ProVestorPlus Company Report, net income grew from $6,891 to $21,906. That’s 33% annual growth. Over that time period, revenue grew an average of 21% annually. Note the IMClone thing broke in Jan 2002 and derailed the earnings train express that was MSO.

If they grew the company 3x as fast as when Martha was in her hey-day, that would be 99% annual earnings growth and 63% annual revenue growth. :-0)

The company has quick and current ratios of 2.5, has zero debt, has reversed the decline in sales growth with this most recent quarter, and has a price to tangible book of 11.8, vs 17.0 average for the printing and publishing industry.

It certainly doesn’t have an outrageous market cap, MSO’s cap is 26th or 27th in its industry.

MSO’s price is justifiable. This Martha Stewart fan rests his case.

I’ll give you the point that all financial results from 2002 on are pretty irrelevent given the scandal.

Since 2001 was the peak before that whole thing, let’s look at those numbers. Sales in 2001 were $296 million, with profits hitting $22 million and earnings reaching $0.42 per share. Sales growth for 2001 was less than 4 percent. Growth rates from 1997 or 1998 are pretty irrelevent, especially 7 or 8 years later.

It is entirely possible that MSO could get back to its peak sales/earnings level in 2007. The stock today trades at more than 60 times those peak earnings.

The growth rates needed from 2008 and beyond in order to justify a 60 P/E are pretty high… too high in my opinion, given that growth had already slowed tremendously even before the Imclone story broke.

Regardless, it should be an interesting transformation, and we’ll see whether current growth expectations reflected in the stock price can be met.

Good luck! (I’m assuming you’re long the stock)