Starbucks Stock, like its coffee, is overpriced

TheStreet.com - February 10th, 2010 - by Gregg Greenberg

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LA JOLLA, Calif. (TheStreet) -- Harry Rady, manager of the Rady Contrarian Long/Short Fund(RADIX Quote), says Starbucks(SBUX Quote) shares are overpriced and worth shorting.

Welcome to TheStreet's Fund Manager Five Spot, where America's top mutual fund managers give their best stock picks in five fast and furious questions.

 

Are you a bull or a bear?

Rady: As a value-oriented, contrarian, long-short manager, I am both a bull and a bear. Given the recent "junk rally," it's a tale of two markets. Many second-tier, lower-quality companies have risen too much, too quickly. This has created extraordinary opportunities for us on the short side.

Conversely, many high-quality, dominant companies haven't participated in the Junk Rally, which has created a similar opportunity for us on the long side. So basically we're buying undervalued high quality companies and shorting overvalued low quality companies. Given our long-term track record of identifying stock market opportunities and inefficiencies like these, we have a high level of conviction about the risk-reward profile of our portfolios.

What's your favorite long stock idea?

Rady: The market dislikes utility stocks right now and has driven the prices down to very attractive levels. Many of the best-run utility companies in the world have seen their stocks decline by more than 50%, which puts their valuations at decade lows. Most of them are dividend-paying, blue-chip companies trading at 50% discounts -- on a price-to-earnings and intrinsic value basis -- to the indices. This enormous valuation gap has created an extremely unique opportunity for deep-value investors like us, who are willing to look past the current quarter's earnings and focus on the longer-term intrinsic value. We own a number of stocks in the sector but a good example of one of them is NRG Energy.

What's your favorite short idea?

Rady: On the short side of our portfolios, the stocks aretypically trading at or near their highs and Wall Street loves them,thereby driving valuations and expectations to unsustainable levels.These types of companies are vulnerable to market declines or smallearnings disappointments. Starbucks(SBUX Quote)is one such company that we believe has risen too much, too quickly andmay be vulnerable. Most long-short managers aren't able to generatealpha on the short side of their portfolios sustainably. To date, wehave been fortunate in this respect. Historically, our shorts have beenan important part of our long-term performance.

What's your favorite sector?

Rady: As contrarian investors we gravitate to sectorsthat are out of favor, as long as the stocks have declinedprecipitously. However, we don't just buy stocks because they're down.We spend an inordinate amount of time analyzing the issues that cause asector to decline, and making sure that a given sector is only facingtransitory issues as opposed to permanent impairments to their business models.

Some sectors that look attractive to us that have declined significantly and represent good values are some of the drug and biotech companies,given their relative economic insensitivity. We are also attracted tothe video-game space, which is out of favor and trading at lowvaluations. I'm a bottom-up investor that looks for stocks that aremispriced. Therefore, to a certain extent, sectors and markets don'tmatter much to us. It's a market of individual stocks that we'rebuying, not the whole sector or index.

Which sector would you avoid?

Rady: We typically avoid sectors whose stocks aren't mispriced enough to create opportunities on the long or short sides. We may also avoid sectors whose volatility and risk is simply too great to justify allocating capital. The financials would be a good example of a sector that's facing such issues, but this type of uncertainty may also create opportunity in the future.

-- Reported by Gregg Greenberg in New York.