The NASDAQ Composite Index had a good month last week, up almost 3% in just five trading days.  Of course, much of that is due to the time of the year as December is not only the penultimate month for the holiday spending season but also happens to be the final month of the calendar year.  For that reason it is not unusual to see exaggerated stock price movements, partly in response to better (or worse) than expected holiday sales figures compounded by year-end “window dressing” by late-to-the game portfolio managers.

With the NASDAQ up more than 1,000 points this year (+33%), what portfolio manager does not want to show most of its leading component stocks in their portfolio?   Though Facebook (NasdaqGS: FB) may be trading at more than 140 times TTM earnings and pays no dividend, it is easier for portfolio managers to rationalize owning it to their shortsighted clients rather than try making a rational case for not owning it.  The same essentially holds true for Amazon (NasdaqGS: AMZN), Netflix (NasdaqGS: NFLX) and 3D Systems (NasdaqGS: DDD), all current short sell recommendations in our Equity Trades portfolio.  

However, since we are not portfolio managers getting paid commissions or fees to keep you in the stock market, we will make a rational case for not owning these stocks.  In fact, we believe we can make a much stronger argument for shorting them (or buying put options) at current price levels.  Although all four of those stocks now exceed their respective short sell limits, we suggest holding off until mid-January before entering into these positions.

From a historical perspective, a big surge in stock prices at the end of an already frothy year is almost always followed by a sell-off in the first half of the following year.  It is precisely when most investors eschew the tenets of the principle of “reversion to the mean” that they tend to revisit the financial markets with the greatest impact.

To be clear, that’s not to say that there aren’t bargains to be found in this market.  Our Equity Trades portfolio also includes two buy recommendations, Ricoh (OTC: RICOY) and Riverbed Technology (NasdaqGS: RVBD) presently trading below their respective buy limits. 

Our Investments portfolio also recommends ten stocks, nine of which are currently priced below their long term buy targets as summarized below (please note that the lone exception, EMC, has appreciated 7% since we first recommended it only 11 days ago and is now slightly above its buy limit of $24). 

PORTFOLIO UPDATE

The only change to either portfolio is the removal of Micron (NasdaqGS: MU) from our Investments portfolio based on its recent price strength.  When we first put together our initial set of recommended portfolios last month MU was trading below $20, but recently has surpassed $22.  While we like the company and may add it to our Equity Trades portfolio sometime in 2014, we’d first like to see earnings catch up to the substantial appreciation it has experienced in recent months.  Micron is now a ‘hold’ until further notice.

PORTFOLIO SUMMARY

• Portfolio updated: Thursday, December 19th, 2013 12:46PM

LEGEND:

BiQ = Boeckl Innograton Quotient.  It is a scale from 0 – 10 that reflects the extent to which a company possesses the critical elements of innogration, and includes a score for dividend yield (0 – 3), change in operating cash flow (0 – 3), and innogration strategy (0 – 4).

STR = Smart Tech Rating.  It is the BiQ adjusted by the ratio of a company’s forward twelve months earnings per share multiple (FTM) to the same ratio for its peer group.  For example, a company with a Biq of 5.0 is trading at a FTM of 30 versus an FTM of 15 for its peer group, so its BiQ score would be reduced by 50% (15/30) for an STR of 2.5.

Stop Loss is the price at which a stop loss order should be set to protect you from excess loss in the event a stock does not behave as we anticipate.  For a long or buy position a stop loss order would be set below the current price, and for a short or sell positon a stop loss would be set above the current price.

IN FOCUS

Video Gaming Grows Up

Later this week many very happy children will tear open packages containing all sorts of electronic gadgets, including a number of recently released video gaming consoles.  Microsoft (NasdaqGS: MSFT) announced earlier this month that it sold 2 million units of the most recent iteration of its Xbox console in the first eighteen days it was on the market, almost identical to the 2.1 million units sold by Sony (NYSE: SNE) of its latest PlayStation device.

Over a decade ago I had been invited to Microsoft’s executive partner summit. During the course of the three day conference Microsoft presented its latest and greatest new products that they had been developing. Aside from the 6.8 Richter scale earthquake that occurred smack in the middle of Ian Rogoff’s presentation, the one development which completely shocked me was the beta version for their X-box gaming system. It was so lifelike and fluid I was as stunned as I had been by my first experience with an earthquake.

Gaming consoles had been popular back in the 1970s and 1980s but had quickly died off as the Personal Computer became increasingly powerful and appeared to be the heir apparent for the gaming needs of the future. Why sit down at a stiff and monotone Pong console when you could enjoy the color graphics and stereo sound effects of a game on your PC?  I still have my original Atari console which I have kept more as a historical artifact like that of a dinosaur bone.

However, the gaming systems of the early days of the 21^st century have become increasingly robust. The major force for revitalization had of course been the invention of the Internet. Online gaming is all the rage today given the power of these networks-enabled systems making them available on social networking sites such as Facebook (NasdaqGS: FB).

The burgeoning Cloud enables these gaming systems to take their place as complete endpoints of the future. In addition to gaming, the latest offering from Microsoft also functions as a phone via Skype, has an Internet Explorer App for browsing the web along with embedded media platform for movies via the Netflix App.

With the latest release from Microsoft, they have put out notice that they can be viable in the post-PC world, which is in decline. As Microsoft generates revenue selling its Enterprise software, seeing them producing a second profit engine is a welcome site. With the right CEO to replace Ballmer, Microsoft has the opportunity to return to its winning ways in the marketplace.

At STI we use the term “innogration” to quickly describe a company’s management of technological innovation and the integration of existing external technologies in and around their products. As no company can either own or create all market-critical innovation, their management of innogration is decisive as to how a company will perform in the future. A company’s strategy is, in effect, its plan for innogration.    

Sony sells the PlayStation – its competing gaming system to Microsoft’s Xbox. Microsoft has clearly jumped out in the lead with its Xbox offering but if Sony can innograte within its own ecosystem it could take advantage of the content which Sony owns via Sony entertainment.

Personally we prefer the model of companies which don’t have to make the investments to create the content for resale; therefore, Apple’s iTunes and Microsoft’s x-box are better business models in our opinion. However, Microsoft has shown the marketplace how compelling of a blueprint the gaming systems really can be.

Google (NasdaqGS: GOOG) has underwhelmed the consumer world with its TV set top box. Though one can search via Google’s Chrome browser while having access to media such as Netflix movies, the market has stayed away in droves. With Smartphones having search capacity, the need for a TV set top box with that functionality has yet to catch fire.

Google’s approach of offering inexpensive or free tools has been utilized more by tech enthusiasts than the general public as Google doesn’t invest in elegant user interfaces, which is off-putting to the average consumer. Further, the later LCD TVs and even some Blu-ray players have what are called “Smart widgets” which enable users to play Netflix type movies.

Therefore, without the marketing and clunky user interfaces only engineers can love, Sony has the opportunity to reinvent itself through an innogration strategy and take a serious leg up over TV LCD makers and Google widget offerings. Most of the LCD widgets I have experienced are not full screen and possess so little functionality that I simply don’t use them.    

The Xbox gaming system can be a real game changer for Microsoft, and Sony. In Microsoft’s case the company appears to have made Windows 8 specifically for the Xbox as the new user interface is quite poor on PCs. Given the right CEOs executing a compelling innogration strategy for both Sony and Microsoft – they have the opportunity to take gaming systems from a niche product for the younger set and create category killers.

Every endpoint, be it Smartphones, Tablets or Gaming Systems, must have the “killer apps” which make their functionality such that they become viewed as must-have or indispensable. Smartphones and Tablets are already there – they are viewed as required. Gaming systems have not travelled into that stratosphere – yet.

Apple’s (NasdaqGS: AAPL) purchase of the Israeli company PrimeSense shows that Apple either now considers gaming systems to be a threat or is interested in entering the gaming space. PrimeSense makes chips that observe a scene in three dimensions. Microsoft uses PrimeSense chips in its gaming systems.

Apple could be making a strategic move to disrupt a winning revenue flow for Microsoft with the acquisition, or they could be interested in entering the gaming space for the revenues it can yield. Only time will tell if this is a move to subvert Microsoft innogration or extending Apple’s innogration into yet another winning category for the Cloud age.

Given that gaming systems all began with Pong and then grew from there to Pac Man and Asteroid arcade gaming systems, the growth of the gaming space is a surprising development. However, it does illustrate innogration in action and at the same time how far these gaming rigs have traveled. STI will be watching this space to see if Microsoft and Sony can make the move to future endpoints with their gaming systems.

Stocks mentioned in this article:

MSFT is a ‘Buy’ up to $42

AAPL is a ‘Buy’ up to $595

GOOG is a ‘Hold’

FB is a ‘Short’ above $55

SNE is a ‘Sell’