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Bet Against the Crowd with Two Web Security Stocks Stuck in the Dog House

By Michael Brush
Exclusively for InvestorIdeas.com
August 10, 2006

One of the riskiest things you can do in the stock market is run with the crowd. History shows that whenever sentiment goes to extremes and everyone believes something, it’s a good time to bet the other way.

It may sound arrogant, but the truth is that once almost everyone is on to a theme and making the same bet, that’s often about the time the bet turns out to be wrong.

Think tech stocks in early 2000, the sell off after the 9/11 terror strikes, or energy plays at the end of April.

Right now, negative sentiment is so widespread in the stock market, you are definitely part of the crowd if you are in cash or have short positions.

Bad place to be.

Consider this: A bull-bear ratio of market commentators recently slipped to 1.08, nearing its lows around the time market bottom of October 2002 and just after the 9/11 disaster. You don’t get much lower than that.

It’s one thing to simply avoid the crowd, however, and another thing to bet against the crowd because there are obvious reasons the crowd is wrong. I think that’s where we stand now. Here’s some evidence that the economy is not as bad as everyone thinks, recently published by Ed Yardeni who is an economist and market strategist for Oak Associates.

Orders for capital goods – except computers and semiconductors – are in a solid uptrend. Orders, shipments, and earnings are at or near record highs at companies in industrial machinery, electrical equipment, construction equipment, aerospace, and machinery used in mining and drilling.
Compensation levels and productivity continue to rise at impressive rates. Employment is high. The consumer – who drives our economy – is not about to roll over.
A capital spending boom in nonresidential construction is underway. This kind of spending is rising at the strongest pace since the start of the decade.
Strength in industrial commodity prices shows the global economy is booming.
U.S. companies have solid profit growth and strong balance sheets which should support continued strength in capital spending.

“It seems to me that the alarmists are a bit too hysterical,” concludes Yardeni.

If he is right, it makes sense to buy the economically-sensitive and cyclical names that have been beaten up so badly since early May. One cyclical area that’s particularly out of favor – but likely to benefit from continued economic strength – is technology.

Here are two web security companies that have been pummeled because of the general aversion to tech. They’ve each gotten an extra wallop of disrespect for being in the midst of transitions that create uncertainties among investors.

Insiders don’t seem that concerned. They have stepped up and purchased in a big way. This makes sense for investors, too, as long as you are adding small positions in these stocks to a well-diversified portfolio.

Websense (WBSN)

If you surf the web from your office computer, the chances are good that your employer is “spying” on you. Companies know full well it’s a waste of resources when workers spend lots of time on the Internet. It can also eat up bandwidth if workers are downloading movie clips from YouTube. What’s worse, a company’s legal liabilities can increase if employees download porn or frequent hate-based websites.

That’s why many companies install filtering software to keep workers away from what’s known as “the sinful six” in the business. They are: pornography, hate sites, gambling, tasteless material, violent content and illegal activities. The filters allow limited access to sites for personal use, like shopping or sports scores, and block against sites that download spyware to computers.

Companies often turn to San Diego CA-based Websense for this kind of filtering. Shareholders haven’t seen much benefit as of late. The stock has fallen to $18 from $34 earlier this year.

Growth has been slowing because of competitors with lower prices. New product lines haven’t matched the success of core filtering products. Websense is also in the process of changing its distribution system.

“Given these issues, we are on the sidelines with the stock,” says Wachovia Capital Markets analyst Philip Rueppel. He thinks the transition to a new distribution system – an attempt to reach smaller businesses – won’t start to pay off until the second half of 2007.

But chief executive Gene Hodges must think improvements will come before then -- because he isn’t waiting to buy the stock. He purchased $465,000 worth on August 2 for around $18.60 a share.

He’s betting on the success of his company’s strategy of expanding beyond its core content filtering products to security, going after smaller companies, and trying to get more international business.

WebSense also has a cushion of sorts that could protect against further dramatic downside and give managers breathing room in the transition – it has $7 a share in cash and no debt.

Secure Computing (SCUR)

Like WebSense, Secure Computing works in computer network security. It offers security products like firewalls, virtual private networks, authentication, and web filtering.

Also like WebSense, Secure Computing has seen its shares get punished. The stock has fallen to around $6 from $15 earlier this year.

Besides the general aversion for tech stocks, investors are selling because they are worried about Secure Computing’s recent purchase of a content management and messaging security company called CipherTrust. It’s unclear how much deferred revenue at CipherTrust will have to be written down.

Another problem is that two large deals hoped for at Secure Computing slipped at the end of last quarter. More customers may be holding off because they want to see how the new product mix will shape up after the integration of CipherTrust.

But Chief executive John McNulty isn’t waiting. He thinks these concerns are overblown, becaue he bought $300,000 worth of stock at $5.61 on July 31. A few days later, another executive purchased $25,000 worth slightly higher.

“Once the acquisition is finalized, opportunities for out-performance will begin to materialize through cross-selling of products,” says Dougherty & Company Joseph Maxa. He thinks that may happen in the first or second quarter of next year.

The bottom line: These companies look troubled and most of the analysts who cover them are telling clients to stay away. But you often get the best deals on stocks when everyone hates them – except the insiders. Just remember that these two stocks aren’t trades. Instead, it makes sense to buy them with a one- or two-year time horizon as part of a diversified portfolio.

Disclaimer
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

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