The Poor Investor

Investigatory Value Investing

Category Archives: Stock Picks

Bottom Digging During Market Tops

The S&P 500 has nearly tripled from a 2009 low of 735 to 2113 currently.  Just as a rising tide lifts all ships, so too does a rising stock market lift all stocks.  At greedy times like these, investors should be fearful and reexamine their portfolios.

…if [investors] insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.  -Warren Buffett

Now, I’m not saying the market has reached its peak (though some do make compelling arguments).  I am not a market timer and I’ve written about the folly of forecasting in the past; I’m merely saying a prudent investor should not let greed get the better of him.  The following strategy is one that is more likely to be applicable during market highs as investors are more likely to have a preponderance of stocks trading at prices much higher than their actual values (aka, the rising tide theory mentioned above).

So what to do?  Well, I believe the prudent investor should lock in gains on stocks pushing well beyond their valuations (close to 52-week or all-time highs) and replace them with stocks trading at reasonable valuations.  Mr. Market is offering attractive prices for your stocks, let him have them.

But then we’re left with the problem of finding alternative investments.  As markets keep pushing higher and higher, investors are often left scratching their heads wondering where to find value.  Admittedly, this can be challenging, however, opportunities do still exist.

One place to look as stocks reach all-time highs are stocks reaching new 52-week lows.  Some noteworthy examples include PriceSmart, SodaStream, Turtle Beach Corp., and Fossil.  PriceSmart is the Sam’s Club of Central America and the Caribbean.  It’s trading at a small discount to its sales, has high insider ownership, and has consistently grown sales, 15% on average, over the past ten years.  At its current price of $17.07 after-market, SodaStream trades at a large discount to sales (72% of sales) and is nearly trading at its book value of $16.59.  Turtle Beach has near-total domination in the gaming headphone market with 50% of both the UK and US markets.  It trades at 60% of sales (which it looks to nearly double sales this year) and is led by smart management with a solid near-term plan, and patents, to enter industries such as health, automotive, TV and mobile.   I’ve already written my take on Fossil, you can read it here.

The next place to look is at overlooked stocks (often smaller capitalization, less than $100m) in industries where there is a low supply of investment opportunities.  One such industry is the coffee industry.

Now, before going into individual companies, let me preface this discussion by first noting some interesting dynamics at place in this market.  For one, coffee consumption is not nearly what it used to be.  In fact, in 1946 consumers drank 46.4 gallons of coffee per person (Figure 1).  Today, even with a coffee shop on every corner, consumers drink less than half as much at only 20-25 gallons of coffee per year as coffee was replaced predominantly by soda.  As consumers become more health-conscious, pop consumption should decrease and coffee, as a viable, healthy alternative, should have an increased level of consumption.  Secondly, there is a shift taking place where high-quality shade-grown coffee (high cost to grow) is being overtaken by the rise of poorer quality shade-free coffee (cheaper to grow).  This makes coffee plants much more susceptible to climate change and topsoil erosion.  As climate change concerns begin to grow, the downfall we’ve seen in coffee prices from $300 in 2011 to a current 52-week low of $140 is not likely to last.

Figure 1

Figure 1

Now, opportunities in this market surely exist in the form of large companies.  There is, of course, Green Mountain Coffee Roasters and Starbucks, but investors in those companies will soon bail when they see these companies for what they are—overvalued.  Starbucks trades at an all-time high ($94.30) and the highest price-to-sales ratio it has ever seen in the last ten years of 4.12.  Starbucks also trades inversely to coffee prices.  Green Mountain Coffee Roasters ($124.10) shares trade even higher at a price-to-sales of 4.31 and, like Starbucks, it is also inversely correlated to coffee prices.  As coffee prices rise investors will bail on these two companies (and valuations will come back down to earth).

So when investors bail, where will they look?  On the conservative end is Coffee Holding Co., trading at 28% of its total sales.  This company is well-managed by its owners, experienced coffee industry veterans, who have a 10% stake in the company’s shares.  They also support and believe in sustainable practices.  These beliefs lead to production of higher quality coffee (shade grown) that is not as susceptible to soil erosion and climate change.  Furthermore, as experienced coffee experts, they are well-hedged against fluctuating prices.  On the risky end is Jammin Java, better known by its Marley Coffee, which is trying to force itself to turn things around before it does a complete nose-dive.  If company-estimated year-end sales are to be believed, the company trades at a 10% discount to expected year-end sales.  However, this company is only for high-risk-oriented individuals who don’t mind getting cleaned out if things turn south.

Then, there’s the oil industry.  I don’t think I need to go into this a whole lot as many have already witnessed the price collapse at the pumps, so suffice it to say that there are many opportunities to be had in this sector, both large cap and small, and everything in between.  (Check out Cale Smith’s recent notes about the oil price phenomenon).  I’m pretty sure you could throw 10 darts at oil stocks right now and make at least 8 solid investments.

Another interesting idea is James O’Shaughnessy’s strategy of looking for stocks that he calls Reasonable Runaways.  These are stocks that have a high relative strength, greater than $150m in market cap and trade at a price-to-sales ratio less than 1.  I’ve modified this strategy a little bit by including companies that have large amounts of cash in excess of debt.  Some notable examples include FreightCar America Inc., BeBe Stores, Men’s Wearhouse, LSI Industries and FujiFilm Holdings.  While I have not had time to look into each of these companies it doesn’t matter— the theory of the Reasonable Runaways strategy is one of investor agnosticism.  The theory says that you are buying $1 worth of sales for less than a dollar (low P/S) just as investors are realizing the company is undervalued (high relative strength).  You simply run the screen, buy agnostically, and diversify your portfolio by giving equal weight to the top 20 or so companies with the highest price appreciations.  Sell after a year then repeat the process.  Since 1951 this strategy had a compound annual growth rate of over 18%.

While the S&P 500 may have reached its top, your portfolio doesn’t have to top-out.  You can simply shift your current best performers to companies that offer greater opportunity and more attractive valuations.  Employing several different search techniques, such as those mentioned above, can get you on the right track to optimizing your portfolio towards value and thus reducing your overall risk by increasing your margin of safety.  But don’t forget to hold on to a fair amount of just in case cash for when the market does plummet.  You’ll want to have that cash in your back pocket to snatch up undervalued companies when the falling tide lowers all the ships again and more opportunities abound.

Disclosure: Long Coffee Holding Company (JVA) and Fossil (FOSL)

Fossil: A Diamond in the Rough

Fossil recently reported earnings that “The Street” did not expect. Forward guidance was not as optimistic as expected either. Investors reacted by a massive sell-off, resulting in the stock dropping over 19%, from $99 to $80. I believe this was an extreme overreaction.

While there are worries that a company like Fossil will go the way of Kodak (fear that traditional watch companies will be replaced by Apple), these worries are inconsequential to the company as it stands today. Even if the company takes a hit to sales (which is expected), the stock is still attractive at today’s price as a short-term holding (although it should be noted that I generally recommend long-term holdings).

While I don’t see Fossil to be in the same category as what Warren Buffet might deem the “forever category,” I’m sure someone could make the argument for Fossil as a long-term holding.  Obviously though, there is much to be said about the impact new technologies have on long-standing companies.  For instance, a forward-thinking company like Tesla could easily replace the entrenched automakers such as Ford, GM, Toyota and Honda, just as Netflix replaced Blockbuster. Not to mention, since the 50’s, the average lifespan of a Fortune 500 company has dropped from 61 years to 15 years.  But, the long-term argument is an argument for a different post.  My argument, however, is merely a valuation argument.

So back to brass tacks…

The company stated in its latest earnings report that it expects the following for fiscal 2015:

• Net sales to be in the range of a 3% decrease to a 1% increase
• Operating margin in a range of 12% to 13%

Current net sales sit at $3.51 billion. Being conservative, let’s assume a 5% drop in net sales. Conservatively, let’s say only 8% of that translates to net margin, so $266.40m. At the level of current shares outstanding, 51.3m (diluted), this translates into an EPS of $5.19 per share. At this extremely conservative level, assuming the company buys back no shares, this puts the PPS at $62 at the current P/E of 12.

But this is not the full story. The company has $1.1 billion in its coffers earmarked for share repurchases. Assuming the company will “strike while the iron is hot,” and use the full amount to buy shares aggressively after the recent drop, this allows for 12.0m shares to be repurchased, even if the company buys them for $92 per share on average ($7 per share more than the current market price). This would put the share count at 39.3m. Thus, using the previous assumptions, the EPS translates into $6.78 and a PPS of $81.36.

However, this is an extremely conservative scenario. I would go as far to say that this is the “extreme worst case.”

A much more plausible scenario would be a slight decrease in net sales, say 1%, and net margins near 9%. Also, P/E would revert more in-line to what the company traditionally trades for, for conservative investors’ sake let’s say around 15 (actual five-year average P/E is 18.8). Using these assumptions, and assuming no share repurchases, this translates into a PPS of $73.15. Now, no repurchases is extremely unlikely. Assuming repurchases at the $92 level (same as above) the PPS would translate to $119.37.

Moderately optimistic and optimistic scenarios need-not be included in this evaluation. The main thing is figuring out what the downside risk is. For those that missed the point, it is virtually nil. Assuming the reality lies somewhere in the middle of the “moderately optimistic” and “pessimistic” view, this would bring us back to the “plausible” scenario. Hence, I’m arguing the stock will easily trade within the range of $100-120 in the near-term future (less than 1 year).

If the company does not aggressively repurchase shares, and say, only repurchases half of the above assumed amount, a $100 PPS is still easily obtained at 15 times earnings. The most realistic pessimistic assumption translates to $80 in PPS. This translates into a $5 per share loss at the current market price of $85, or a decrease of approximately 6% (though, if this lower PPS level is reached then the company is more likely to repurchase shares, thus putting upward pressure on the stock price). The potential upside, conservatively speaking, is around 17-41%.  Thus, the risk-reward seems incredibly favorable at the current PPS.

Disclosure: Long FOSL

Track Record is Everything

In a book by Peter Krass called The Book of Investing Wisdom, there is an essay by Warren Buffett entitled Track Record is Everything.  The crux of this essay is that past performance history, aka track record, is one of the best single guides as far as judging businesses and investments go.  With that in mind, I thought it’d be useful to show readers of this website what my track record has been thus far for recommendations made on this site.  This should help new readers judge whether the information they obtain from this site is useful.  Though, I should note, as most of my regular readers know, I do not often mention stock “picks.”  However, I do recommend some stocks from time to time to help illuminate some idea or point out glaring inefficiencies in the market (see my post on Apple).  Although, these recommendations come with the caveat that every investor should do his or her own research before coming to a conclusion.

So, let’s get right down to it.  Here is how my “picks” have performed:

Stocks Recommended Recommended
Date Symbol PPS at Date Current PPS Sell PPS Sell Date % Change
9/13/12 dell $10.63 N/A $13.85 2/24/13 30.29%
9/13/12 nvda $13.68 $15.21 N/A N/A 11.18%
9/13/12 atri $218.87 $269.40 N/A N/A 23.09%
3/11/13 aapl $431.72 $515.00 N/A N/A 19.29%
4/22/13 ntcxf $0.81 $1.07 N/A N/A 32.10%
Average= 23.19%
S&P Return (since 9/13/12)= 22.01%
Difference= 1.18%

So far, my “picks” have out-performed the S&P 500 by 1.18% (used the first pick start date for simplification purposes).  Only one sell recommendation, Dell, was given so far.  Now, as Warren Buffett clearly notes in his essay, a 5 – 10 year track record is much more important in making judgments.  However, this site has not been around that long to establish such a track record.   At that time, I will revisit this topic.

Apple’s Stock and the Voting Machine

Peter Lynch put it quite simply by saying, “Buy what you know.”  Now, I’d be remiss if I didn’t mention that there was a study showing this often does not work.  Here, however, it does.

The other day I walked into an Apple store to check out the iPad mini.  It was like walking into a swarm of bees in a beehive.  People were everywhere.  Everyone I know loves Apple’s products and owns at least 1 apple device.  Those I know who don’t own an Apple device plan on buying one in the near future.  I’ve used other products, talked to others who use other products, and everyone admits these devices aren’t as good as Apple devices, this includes: phones, computers, MP3 players, portable tablets, etc.  Apple products are vastly superior in every category, there’s really no debate.  The only reason you wouldn’t buy an Apple product is because you were interested in saving money, with plans to purchase one in the future when the price goes down.

As for the current state of Apple’s stock, Peter Lynch has something else to say about that:

“When even the analysts are bored, it’s time to start buying.”

There’s no question that analysts are bored with Apple, but, really, who cares?  Apple’s stock is a no-brainer at $431.72 as I type right now, March 10, 2013.  The company has $137b in cash.  With that amount of cash Apple could buy Ford and Honda and almost have enough money left over to buy Tata Motors at the companies’ current market valuations.  This is an insane amount of cash for one company.  If Apple has any problem, it’s having too much cash, not the worst problem a company could have.  Personally, I think Apple should follow in the footsteps of IBM and buy a massive amount of its own shares.  Its current share buyback program only allots $10b for this endeavor.  With $137b in cash, that is chump change.

Apple, according to a recent press release, plans on returning a lot of that cash to its shareholders:

“Apple’s management team and Board of Directors have been in active discussions about returning additional cash to shareholders. As part of our review, we will thoroughly evaluate Greenlight Capital’s current proposal to issue some form of preferred stock. We welcome Greenlight’s views and the views of all of our shareholders.”

Cash considerations aside, Apple trades at a current P/E of 9.79.  This is well below the 5-yr. average P/E of 15.6.  Furthermore, Apple’s P/E has never been so far removed from the S&P 500’s P/E as it is now, trading at ~40% below the S&P 500’s (~43% below the Nasdaq’s), with Apple’s average P/E being 64% above the S&P 500’s since 2003.

If the P/E is any indication of investors’ expectation, they don’t seem to believe that Apple will grow much faster than ~10% per year.  However, over the last 5 years Apple has increased earnings by an average of 63% per year.  If Apple continues growing at even half that rate, you’d be looking at EPS of ~$174 by 2017.  This would equate to a share price of $1703.46 at the current P/E.  Now, I must reiterate, this is the half-growth scenario.  Staying at the average current growth rate would mean a share price of $4973.32.  Now, my hypothesis is that we land somewhere towards the lower end near $1703, taking into consideration that the market discounts the future and that the company is not going to realistically grow into being 20% of our economy— but this would still amount to almost a 4-fold gain in under 4 years.  Furthermore, either way growth pans out, you’re looking at what could be over a trillion dollar company sometime in the 2014-2015 range.

With growth and P/E considerations in mind, read these quotes by famous P/E investor John Neff:

“Low p/e multiples usually languished 40 percent to 60 percent below prevailing market multiples.”

“Low p/e companies growing faster than 7 percent a year tipped us off to underappreciated signs of life, particularly accompanied by an attention getting dividend yield.”

As shown earlier, the p/e multiple does languish more than 40% below prevailing market multiples.  Also, Apple is growing much faster than 7 percent with a pretty astonishing dividend, for what I still deem a “growth company,” of 2.46%.

Peter Lynch would love this stock, especially when looking at the P/E in terms of the growth.  While Yahoo gives a PEG of 0.5, Peter Lynch looks at it a slightly different way.  He takes the long-term growth rate, which I estimate on the low side to be 30% (Yahoo’s estimate is 20%), adds the dividend yield, 2.46%, and divides by the P/E ratio, 9.79.  This gives 3.3 for my estimate vs. 2.3 for Yahoo’s.  In One Up on Wall Street Lynch describes the interpretation of these values as the following:

 “Less than a 1 is poor, and 1.5 is okay, but what you’re really looking for is a 2 or better.”

He goes on to give an example of a stock that scores a “3” and deems it “fabulous.”  If we say that the number will most likely fall somewhere between these two estimates, 2.3-3.3, we’re looking at a stock Peter Lynch would undoubtedly rate as a “strong buy.”

Now, there are concerns that Apple’s moat may be drying up as companies like Google continue to steal market share.  However, in this analysis a margin of safety was added by considering Apple’s stock in light of growth drying up 50%, which isn’t likely to happen.  You have the new Macbook Air coming out, iPad 5, iPad mini 2, iPhone 5s, iMac, Mac mini, just to name a few.  And according to CEO Tim Cook, new products in new categories are on the horizon.  Some anticipate the iWatch as one.  The bottom line: it doesn’t matter what is on the horizon.  Apple could make a car and people would buy it just because it is an Apple product.  Even if Apple didn’t come out with any new products, looking at the company from a zero growth perspective, seen here (provided by Old School Value) for those interested in more advanced valuation methods, Apple’s stock has significant downside protection.

As was said by many great value investors, “Protect the downside and the upside will take care of itself.”

Let’s forget the growth concern altogether. A huge aspect not talked about very often is the strong IP position Apple has, illuminated below, from this article:

“…Apple is falling back on its IP portfolio to protect its market position. Generating revenue by suing other companies is not the ultimate goal of Apple’s recent lawsuits. Rather, each case that Apple wins confirms the validity and enforceability of its patents to its competitors. Apple can then license its patented technologies and designs and charge Google and other competitors for using them, piggybacking on their competitors’ success.

It would appear that Apple’s business model is evolving into two modes. First, use a closed model to develop innovative technologies for sophisticated user markets; patent the utilities and designs that the company engineers. Second, license those utilities and designs to businesses that wish to use them. So long as Apple continues to be the first of its competitors to patent new technologies, combining both modes would create serious revenue for Apple and help it maintain its leadership position.”

So… to reiterate the absolute absurdness of this price and to lighten things up a bit, watch this video of Bill Maher and his guests talking about Apple:

And although this video is older, I still find it extremely relevant to this post:

As Ben Graham famously said, “In the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine.”  Long-term shareholders that buy Apple at this price can take advantage of this phenomenon.

Disclosure: Long AAPL

What’s Next?

A lot has happened since I last wrote…  Mitt Romney chose Paul Ryan to be his running mate.  The European Union seems to have gotten its act together, financially speaking.  Facebook reached a new low and Amazon reached a new high.  Even the auto market has maintained most of its steam in the wake of the European Crisis.  In conjunction with this mostly good news, the stock market has also risen to new heights—following its usual trajectory during an election year.

So what does this mean for the future of the stock market?  Well, I will not pretend to know what will happen with the stock market overall, but there are still plenty of stocks out there that I think will provide favorable returns for those who buy individual stocks.  Some of these names will be familiar, some not.  Bargains come in all shapes and sizes (see Ken Fisher’s Debunkery for more on that).

In regards to the aforementioned “bargains,” let’s start with the more familiar.  At a price-to-sales ratio of 0.3 and a dividend of 3%, Dell is my favorite pick out of all the bottom-dwellers.  There is fear that Dell might be a “value trap” and this very well could be, although, I believe Black Friday and Christmas will serve as important catalysts.  As I type from my Alienware computer (Dell-owned), I remember bargain-hunting for it around the same time as the holidays were fast-approaching.  Also, there is a high margin of safety in that Dell is largely considered a value trap.  Value traps may trap buyers, but usually don’t go any lower.  In the end, the catalysts may prove false, but the stock should not depreciate much from this price.

The next in the “familiar” category, is Nvidia.  Now, this may not be familiar to all, but, computer geeks should be plenty familiar with this company.  Although Nvidia was snubbed by Amazon, its new chips are used in Google’s Nexus 7 and will be used in Microsoft’s new Surface tablet.  With around $5/share in cash, the company is effectively trading at  near 11x earnings, for a company that usually trades around 14x earnings.

In the “unfamiliar” category, the company I’d like to start with is Heska.  This company operates in the veterinary market, selling diagnostic equipment and other products to veterinary clinics.  This is a growing market and its growth is expected to continue well into the future.  The company trades with no debt, 16% of the share price is accounted for by cash, and it has a dividend of 4.60%.  As a smaller company, it is still speculative, and will require more due diligence than the more familiar companies.  However, there is more room for reward here if the company can successfully navigate the next few years.

Last, and also in the unfamiliar category, is Atrion Corporation.  This company has shown tremendous growth potential in a growing market— healthcare.  The company manufactures cardiovascular, fluid delivery, and ophthalmic devices.  It has also ranked highly over the years in Value Line’s “earnings persistence.”  The company has a small dividend (1%), positive cash per share, no debt, and boasts a profit margin of 20%.  Although the company has faced some headwinds as of late, it seems poised to perform well in the coming years.  This is another long-term growth story that will require proper due diligence.

In the face of what else is to come, be assured that there are still plenty of stocks out there whose performance will have nothing to do with what else is to come.  These are just a few of them that you might be interested in.  Feel free to mention some more that you think offer a better opportunity for potential price appreciation over the next few years.

Until next time…

The Poor Investor

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