In Fact, There Is No Bubble, Part 2

 | May 12, 2014 | 11:00 AM EDT
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Note: This is part two of a four-part series. See part one here.

As I discussed in part one of this piece, the market is struggling with how to value former leaders. I got to thinking about this whole misvaluation view because of a sit-down I had Friday with a remarkably good company, Shutterstock (SSTK), which uses the Internet to match images that people film with the desires of corporations to have ready images for various needs. There are millions and millions of pictures and videos available, and corporations are thrilled to pay Shutterstock -- and its video creators -- a fee for the use of their wares.

I like the business model very much. Also, it has only one competitor, Getty Imaging -- a private company that serves mostly individuals, not companies, according to the management of Shutterstock.

Shutterstock has got a compound five-year growth rate of 41%, and it could earn about $1 per share this year. In other words, this is the kind of high-growth company that the market used to go crazy about. But let's look at the stock. It peaked at $103 in the last week of February -- almost simultaneously with (CRM) -- and it now trades at $67. This came, moreover, after the company blew away estimates on the top and bottom lines and raised guidance. The stock is now down 20% for the year.

Now, this stock exemplifies the huge problems this portion of the market is having right now. What's the right price to pay for that $1 in earnings? We don't know, and in part this is because this stock flew up to $103 based on sales growth, not earnings growth. If earnings are suddenly in control, and not revenue, this stock has gone from reasonably valued on sales to hideously overvalued on earnings. This is precisely the kind of stock that is in the crosshairs of a market that now measures stocks by EPS and not sales growth. Shutterstock had only been pleasing only one master, the growth hound. It can't now turn around and please the other, the value hound. It has some value, certainly. It's not losing money -- it is making money. But the value is not anywhere up at the levels where its shares are currently trading.

So what to do we now pay for a stock of a company whose revenue is growing at 40%-plus, and which is set to earn $1 per share? Traditional growth-stock buyers -- the ones who got overrun by revenue-momentum-seekers, but who are now in charge of setting prices in this market -- used to be reluctant to pay a price-to-earnings multiple of more than twice the growth rate of a company's earnings. That explains, I think, why Shutterstock blew through $80 like a knife through butter on the way to $67, where it is now. I don't think the current 68x earnings multiple is too attractive, either.

However, stingy growth managers are typically intrigued by stocks that sell at 1x their growth rate when the growth is well in excess of the average stock, as this one is. That means they should get interested at around $40, which happens to be around its 52-week-low from about a year ago.

My best bet is that this is exactly where that stock is headed. Why could it be so severe? Because the market now wants growth in the top and bottom line and it is willing to pay up for growth if it is accompanies by share buybacks and dividends -- two things you aren't going to see from Shutterstock any time soon. That means Shutterstock is more of a short than a long, even down at current levels.

Shutterstock is not alone. There is a whole cohort that looks like Shutterstock. We'll look at those in part three.

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