The Easiest Way to Size up a Stock

Scott McNealy was scared...

Here he was, the CEO of Sun Microsystems, one of America’s most widely held stocks. Millions of smart people throughout America owned his stock. And yet he KNEW thousands of individual investors just like you were about to lose billions in his company.

It’s not that Scott had done anything wrong. On the contrary, he’d done everything right. It’s just... investors couldn’t do some extremely simple math... math that I’ll show you today. It’s math that makes Scott McNealy excited again about his stock, for the first time in a long time.

Scott started Sun Microsystems (NASDAQ:DRAM) in 1982 with $285,000 when he was 27 years old. By mid-2000, the market was valuing Scott’s company at $200 billion. And there was the problem...

You see, sales for the entire company back then were only $16 billion. So Scott did a little back-of-the-napkin math and figured that shares of Sun were trading at well over ten times sales. Right then, Scott McNealy realized that, no matter what, the next few years of his life would be pretty miserable...

Scott reflected on it in BusinessWeek in April of 2002:“At 10 times revenues, to give you [investors] a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends...WHAT WERE YOU THINKING?”

Scott further explained his dilemma back then: “Do I stand up and say “Sell”? I’d get sued if I said that. Do I stand up and say, “Buy”? Then they say you’re Enron Chairman Ken Lay. So I just [did nothing].”

Shares of Sun Microsystems fell by over 90% from 2000 to 2002. How did millions of intelligent Americans make such a bad investment decision, by buying a stock at ten times sales?

The reason is simple. It’s this: Not many people understand the basic principles of building a lasting fortune – how to create True Wealth. Instead people like to chase what’s hot... what’s already gone up. In other words, they like to chase what they’ve already missed.

At DailyWealth, we look for three things in an investment... a 1) great value, 2) that’s hated, and 3) in an uptrend. By the end of 2000, Sun Microsystems was exactly the opposite of these things... it was a terrible value (at over 10 times sales), it was loved by everyone, and the downtrend that would eventually take it down over 90% had just begun.

While Sun was a terrible investment in 2000, here in 2005, it might not be that bad... In the current issue of Fortune Magazine, Scott McNealy says:

“We’re hot... We’ve got a market valuation of $13, about 1.2 times revenues, which is a wonderful (market) valuation. ...I think the next five years will treat us nicely”

Scott can finally tout his own stock, that’s at one times sales instead of ten times sales.

It’s funny, Scott’s pounding the table, and nobody cares. The stock was loved at ten times sales, and now it’s written off at one times sales.

At DailyWealth, we’re not excited just yet.

Quite frankly, the share price is still not that far from 9-year lows. The uptrend doesn’t seem to have begun yet. And we don’t like to try to catch falling knives (it’s much safer to let them hit the ground and settle a bit before we move in).

So we haven’t done the investigating. (Quite frankly, we're not particularly technically-minded... If you covered the labels, we couldn’t pick a Sun product out of a lineup.)

But the point of this letter is not to decide whether Sun Microsystems is a good or bad buy. The point is, you don’t want to buy a stock at 10-times sales. If you own a stock that trades at 10-times sales, WHAT ARE YOU THINKING?

By the way, ever heard of Google (NASDAQ:GOOG)? It’s currently at 20 times sales.

Have you ever heard of the guys at Google touting their stock?

Me neither...

Good investing,

Steve