As mentioned in earlier posts, value investors like to make use of assumptions that they can be relatively certain about (i.e. last twelve months' earnings, balance sheet valuations, etc). Even so, we know that nothing ever plays out as one would expect. As such, we make use of a "margin of safety". This means that we will never buy into a security at its full intrinsic value (unless there are some pretty certain growth prospects which will be discussed in the next post).
Once the intrinsic value is calculated, an appropriate margin of safety is considered in order to arrive at an entry price. If the security can be had for less than this entry price it should be purchased.
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For those readers that are just joining us now, this is the 5th installment of a "basics" course on value investing. This is important preparatory reading, especially if you are very new to value investing, in order to understand valuations which will be discussed on this site. You can access the entire course by clicking on the "basics" link under the topics heading to the left. I also recommend subscribing to this site's RSS feed by clicking the orange link to the right.
The next post will discuss the value of growth and will conclude the posts on value investing basics. There will definitely be more educational posts in the future but these 6 articles are the basics required in order to understanding an investment thesis on this site.
Hello Jonothan,
ReplyDeleteI am an avid reader of your school pal (Barel Karsan), which thanks to him is how i found your site.
While i don't always follow others opinion i will take you up on your offer to 'value' two companies i have looked at.
Please peek at The North West Co. and Akita drilling. I know the latter is in a tough field but the p/b and past p/e without leverage are hard to ignore.
If your really bored have a look at collectors universe too.
thanks
Derek
Optionsnut,
ReplyDeleteThanks for checking out my site. Here are my thoughts on each of those recommendations:
North West Co. - Looks interesting. I like the companies in the portfolio and I think there is a possibility of a franchise there given the markets they serve. Added to my list, if it ends up being a buy you may see it on the site in the near future.
Akita Drilling - I tend to stay away from companies involved in Oil and Gas as their income is very dependent on the price of oil which is a very volatile commodity. While this companies profits are directly related, they will only see a rise in activity if their customers pick up investment. Right now there are so many opinions on whether Oil is undervalued or whether it can get even lower and stay there so this just doesn't excite me and I will stay away from it for now.
Collectors Universe - With negative operating income over the past two years I would stay away from this one. Value Investing is a time-intensive process and with so many other options out there that are profitable I wouldn't spend time valuing this. Also, to value this we would have to forecast what would happen with revenue and expenses going into the future, that's a dangerous game to play into. As a value investor I want to look at a profitable company and extrapolate it's earnings to see what it is worth based on current profitability. I will then pay for the value based on that. If I were to do that with this company then I would obviously pay nothing for it. There is definitely value here however (liquidation value, etc) but like I said there are enough companies out there that are definitely viable and I would rather spend the time looking at them.
Thank you for visiting my site and I hope you check back regularly!
Best,
Jonathan
Hi Jonothan,
ReplyDeleteI mostly agree on your first 2.
I will say that drillers, shippers and newspapers will have their day again. Picking a few now or earlier could have been rewarding, but i would only make it a small part of a larger plan.
With respects to Collectors one needs to dig deeper. I will say this is the only one i currently own of the 3 and will buy more if it dips below $3.
After reading the statements on Edgar you get an idea why the earnings for Collectors were negative. They purchased a gem grading business in and around '05. This was a continual drag on them and they never did get it profitable.
The past few years Collectors has had negative earnings due to the goodwill write offs. This gem business was disposed, early '09, and lo and behold Collectors showed a profit last Q.
Now i believe this profit has always been there its just been hiding...
If you knock out the cash against the total value paid for the business one would get a p/e of mid single digits with 0 debt and p/b (no goodwill fluff) of 3 to 1 @ $4.
Due to the recent share buy back done in June the market cap should be 7,408,516 shares * $4.1 = $30.4 million. Now take the remaining cash it has (including receivables) and pay off all debts which leaves $8-10 million.
Put the cash against the market cap (because if you look back all they've done is pay out cash or buy back shares) it means your paying roughly $20 million for about $3million/yr earnings. ..... for a conservative p/e of under 7.
Oh and i doubt this business is impossible to penetrate, but it does have a decent moat. Just check out their next earnings due in about a month. They should have $800,000 profit unless they have some mishaps?
Please check if i have any errors, because i have used msn for some numbers... but in the past checked with Edgar to confirm.
Derek
Hi Derek,
ReplyDeleteI just checked the EDGAR filings. Doing some VERY rough calculations (just to get a sense of if it was worth looking into further) I arrived at a fair value range of $3.00 - $4.25. This supports your decision to buy if it goes below $3 but remember, this isn't necessarily leaving a decent margin of safety. That is for you to decide.
As I couldn't arrive at a full twelve months earnings with the discontinued operations taken out (perhaps the information was there but like I said I did this rough and quick) I just extrapolated the last 9 months into 12 and used these numbers for my earnings power.
My numbers are very rough but they give me enough confidence to say that this company is trading too high for a closer look currently. If it dropped closer to 3 then yes I would look again to see how much more hidden value there may be. At this point I know nothing about the company besides what you've told me and taking a quick glance at the 10Q and 10K.
Thanks for bringing these companies to my attention. Would love to hear your thoughts on future posts.
Best,
Jonathan