Berko: Sell your Rackspace shares
By Malcolm Berko Taking Stock January 31, 2013 5:46PM
Updated: March 2, 2013 7:39AM
Dear Mr. Berko: In the summer of 2009, I had $5,000 to invest in my individual retirement account and my broker recommended I buy 500 shares of Rackspace, US Inc. at $9 and I’m glad I did. The company is in San Antonio and my husband and I have a friend working there who tells us how enthusiastic he is about this company. Now the broker wants me to sell my 500 Rackspace shares. He says the stock has gone about as far as it can go and says the “downside risks are much greater than the upside potential.” I think he’s wrong but my husband suggested I email you for your thoughts. I want to let this ride because I feel it could go to $600 like Apple Inc.
We are in our late 40s and this is a lot of money to us. We don’t want to make a mistake. The broker wants to use the sales proceeds to purchase Duke Realty, HCP Inc., Ventas Inc., Health Care REIT Inc. and Public Storage, all of which are real estate investments. He says they are good inflation investments. What do you advise?
Dear DE: Apple isn’t $600 anymore and you’re a lucky lady to have a darn smart broker. I advise you to follow his advice. Most of today’s brokers don’t know bupkis about common stocks, so they’re compelled to sell high-commission products — such as variable annuities, index annuities, crazy hybrid insurance products, mutual funds and other heavy-fee proprietary products.
Rackspace (RAX — $79) is in the hosting and cloud computing business. It provides information technology and tools to operate data centers, networks, hardware devices and operating software and it manages Web-based IT systems for customers around the world. RAX went public in the summer of 2008 at $12.50. That’s when revenues were $531 million and earnings were 19 cents a share; its price-earnings ratio was 66-to-1 and net profit margins were 4.6 percent. Last year, RAX had revenues of $1.3 billion, earned 75 cents, saw its P/E rise to 100-to-1 and saw its profit margins nearly double to 8.2 percent.
You’ve got a swell profit, so your broker certainly deserves a gold star for that recommendation.
Sell it. There are thousands of companies like RAX. These IT companies have offices in every major and minor city in the U.S., and new entrants are coming out of the woodwork almost daily. Because the hosting and cloud computing field doesn’t require significant capital for plant and equipment, business is becoming increasingly cutthroat and competitive. Though RAX’s revenues and earnings should continue to grow, they will grow at a slower pace. However, the company’s ridiculous P/E of 100 is historically absurd and off-putting. I know of nothing that deserves a 100 P/E. And if RAX earns $1.20 a share in 2013 as the Street reckons, I doubt the shares will trade at higher than $100 — unless investor stupidity falls a few more embarrassing notches.
I like your broker’s real estate investment trust recommendations. I believe that inflation slowly and silently entombs our economy. Inflation is a hidden tax that silently sneaks upon us and steals the value of our savings and incomes. There’s a steady supply of precious gems and gold, but the supply of land always remains constant. So your broker’s REIT suggestions make enormous sense, especially the health care REITs, such as HCP Inc. (HCP — $46), Health Care REIT Inc. (HCN — $61) and Ventas (VTR — $65). In the coming few years, their values, revenues and dividends are likely to experience promising growth. And with your next cash stash, you might consider owning some Treasury inflation-protected securities.
Address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at firstname.lastname@example.org.