Contrarian Finance

Normally I'm opposed to high risk strategies and investment vehicles, e.g. commodities, options, and selling stocks short. Mostly because I know I'm not savvy enough, or well informed enough, to take on other traders and win. Commodities especially is a zero sum game... one not likely to end in my favor, at least not until I get better educated. And of course, speculating, which is what buying derivative really is, in most cases, is not very contrarian.

So, back to my main idea, is it time to short Mastercard (MA) stock? As I mentioned previously, I like Mastercard as a company, and I did give a investment pick to a friend on this stock. My advice to him was to invest at under $45 a share, and to sell at $70 or above. He bought at $43 and sold at $71. Just over 65% return, not including trading costs, in under 3 months. One of my better picks if I do say so myself (and I do).

But as of the market close today, Mastercard stock is at $96.55. This stock is way overvalued in my opinion. They had some write-offs for IPO charges, etc, which gave them a Q3 loss and so the current P/E, etc, is a non-starter from an analysis standpoint. But a quick check of their forward P/E reveals a hefty 24.69. If you exclude the charges, the other common value ratios fall into line with the forward P/E. Industry peer American Express (AXP) is at 20.83, which also seems high to me. The whole industry average P/E is a perfectly reasonable 14.52. They do have above industry projected growth, 1 yr and 5yr (19.6% vs 16.1% and 15.0% vs 12.53), but that doesn't seem to justify this level of price premium.

Not that you care what analysts think, but in the last 30 days five analysts have downgraded their stock. Goldman Sachs downgraded to a Sell. The analyst stock price targets ranged from $50 to $100, with the consensus 1 year target at about $79. I think their stock will go higher, maybe to $100, or even $105, and that might be the perfect point to go short. I personally think the fair value is still above, but much closer to industry norms. Certainly the P/E should not be above American Express, a company with almost 10 times the revenue of Mastercard, but at this time barely 5 times their market capitalization. I'd still put the fair value at about $65. Which not coincidentally is why I told my friend to sell his stock if it hit $70.

A note about my stock price targets, I don't sell stocks when I think the peak value has been reached (obviously), rather I sell stocks when I think the buyers have lost their sense. Once mob rule pushes the price 10% above full value, it's time to take your chips and leave. Years ago I convinced a couple I was friends with to invest in (er, speculate on) Amazon.com stock. I told them, get in where you can, which turned out to be about $40 a share. I said, let it ride a bit. At around $250 I said, get out while you still can. Of course, it did go to somewhere around $400 as I recall, but that's not the point. After they cashed out what had started as a $100,000 investment they retired (they lied and told me it was $10,000; I'd never invest, or recommend, that much on a speculative play like that, not unless I or my friends were worth at least 10 million that is). In all fairness, they did also sell their insurance business at the same time, but it's a nice story none the less.

Anyway, the point is, as a value investor, and a contrarian, I like to get in when the stock price is below fair value, and get out when it's above fair value. That's my personal take on "buy low, sell high". I'm not trying to call the top or the bottom, to me that's voodoo or dumb luck.

So back to Mastercard... my idea here is basically the inverse of my classic strategy: sell the stock (short) above the fair value and buy the stock (cover) below or at the fair value. If it climbs to $105 or so (5% above the highest price target if you're wondering where I got that number), and it probably will, then short there and wait for the wheels to come off the cart. If I had to guess, I'd say when they post next quarter's numbers, which should be positive, and the actual, not just forward P/E ratio (among other things) sinks in for folks they'll rethink the mini-bubble they've created. And when they run, so will the speculators, and technical traders will start to pile on as shorts... well, you get the picture. Cover when the price drops to $70 or below. That's a tidy profit. You could always hedge against the possibility that the insanity isn't done with an out of the money call, but that's a whole other post. And I need sleep.

Oh, one last though, for you technically inclined types (not technologically, but technical trading types) out there, you could probably use some kind of volume/support indicator to pick the top a bit better. It's too far afield for me, but I offer it for what's it worth. Oh one other thing I forgot to mention, from September 10 to October 10, the number of short positions increased from 3.47M to 5.84M. I'm guessing the recent run-up scared (or forced by margin call) some of these guys into covering, but they'll be back, and in greater numbers.

Let me know what you think. Full disclosure: I do not own shares of Mastercard stock, nor am I short Mastercard stock. For that matter, no one I know personally is long or short either.