Category: Value Investing

Industry Ranks February 2014

Industry Ranks February 2014

Posted on by David Merkel

Industry Ranks 6_1521_image002

My main industry model is illustrated in the graphic. Green industries are cold. Red industries are hot. If you like to play momentum, look at the red zone, and ask the question, ?Where are trends under-discounted?? Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted. Yes, things are bad, but are they all that bad? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled ?Dig through.?

You might notice that? I have no industries from the red zone. That is because the market is so high. I only want to play in cold industries. They won?t get so badly hit in a decline, and they might have some positive surprises.

If you use any of this, choose what you use off of your own trading style. If you trade frequently, stay in the red zone. Trading infrequently, play in the green zone ? don?t look for momentum, look for mean reversion. I generally play in the green zone because I hold stocks for 3 years on average.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh? Why change if things are working well? I?m not saying to change if things are working well. I?m saying don?t change if things are working badly. Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes. Maximum pain drives changes for most people, which is why average investors don?t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy ? no one thinks of changing then. This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year. It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology stocks here, some industrials, some consumer stocks, particularly those that are strongly capitalized.

I?m looking for undervalued industries. I?m not saying that there is always a bull market out there, and I will find it for you. But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive. I don?t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting. The red zone is pretty cyclical at present. I will be very happy hanging out in dull stocks for a while.

That said, some dull companies are fetching some pricey valuations these days, particularly those with above average dividends. This is an overbought area of the market, and it is just a matter of time before the flight to relative safety reverses.

The Red Zone has a Lot of Financials; be wary of those. I have been paring back my insurers, but I have been adding to P&C reinsurers.? What I find fascinating about the red momentum zone now, is that it is loaded with cyclical companies.

In the green zone, I picked almost all of the industries. If the companies are sufficiently well-capitalized, and the valuation is low, it can still be an rewarding place to do due diligence.

Will cyclical companies continue to do well?? Will the economy continue to limp along, or might it be better or worse?

But what would the model suggest?

Ah, there I have something for you, and so long as Value Line does not object, I will provide that for you. I looked for companies in the industries listed, but in the top 5 of 9 balance sheet safety categories, and with returns estimated over 12%/year over the next 3-5 years. The latter category does the value/growth tradeoff automatically. I don?t care if returns come from mean reversion or growth.

But anyway, as a bonus here are the names that are candidates for purchase given this screen. Remember, this is a launching pad for due diligence, not hot names to buy.

I?ve loosened my criteria a little because the market is so high, but I figure I will toss out lot when I do my quarterly evaluation of the companies that I hold for clients and me.

Industry Ranks 6_19997_image002

On Target Prices & Yields

On Target Prices & Yields

Posted on by David Merkel

I know that much of the money management business sets target prices for buying and selling, particularly value managers, and sell-side analysts.? I don’t set target prices.? Why?

Think of what a target price means.? It says that at a certain price you are willing to exchange securities for cash (sell), or vice-versa (buy).? The trade-off between an individual security and cash is difficult to calculate.? Even if you have a really good dividend discount model, the target prices are very sensitive to model inputs.? I think the question of whether I would rather have cash or an individual stock or bond is a difficult question.

So why don’t we focus on easier questions?? It is simpler to rank stocks versus other stocks at least in broad, and bonds versus bonds.? I am not saying that you have to optimize.? You can’t be exact in ranking the desirability of stocks or bonds, but if we can’t identify a group of stocks outside the portfolio that are better than a group of stocks inside the portfolio, there is not much sense in trading.? Same for bonds.

With bonds, the tradeoff is more obvious, because you can consult yield relationships, and make all of the adjustments necessary to decide whether a trade is a good one or not.? Even then, there had better be a good yield advantage after all adjustments, or the trad will not make sense.? As an example, back in the first half of 2002, I engaged in a wide number of trades that gave up some absolute yield, but improved the portfolio’s credit quality dramatically at a time when credit spreads were narrow.? Though overall yield went down, the portfolio was in better shape.? This was the opposite of what we did after 9/11 — buy distressed bonds while spreads were very wide, accepting more credit risks when it paid to do so.

Thus, most of my portfolio management is not so much “Aim for the best.”? I’m not sure I can do that.? “Aim for something better than what I currently have” is achievable.? In cases where I can find no clear improvements, sitting on my hands it the best strategy.? After all, time is on the side of a portfolio representing great relative value.

This is not to denigrate those that are better than me, like Seth Klarman.? He has a strong sense of when he would rather hold cash versus taking any risk, and so he manages value in an absolute sense, even giving back money to clients when? he doesn’t have anything to do with it.

I’m still finding some attractive assets to buy, though not many.? Later this month, I will do my formal quarterly reshaping of the portfolio, where I will trade away a few stocks I like less for those I like more.? And if I can’t find any that I like more, I don’t have to do anything, because if I’ve got a really good group of stocks, doing nothing may be the best idea of all.

PS — If you want more, some of the details are in Portfolio Rule Eight.

On HCI Group

On HCI Group

Posted on by David Merkel

It is not often that I get asked to opine on a domestic insurer that I have never heard of.? Thus tonight’s article on HCI Group.? Here’s the request:

I am a longtime and frequent reader.? I appreciate your value-oriented approach and your genuine desire to help your readers.? (A vast difference from much market commentary!)?

I would be interested in your thoughts on the P&C insurer HCI Group? (HCI).? The fundamentals look pretty good to me, and the company is growing well, but the stock has gotten beaten down in recent weeks, the PE is 8, and there is huge short interest.?

The only news of interest seems to be that they have started writing flood insurance in Florida.? I suppose that is a big hurricane risk.

What are your thoughts?

Florida has had many good years recently of no significant hurricane damage.? This company has a lot of coastal hurricane exposure.

Moving into flood insurance, and undercutting the National Flood Insurance Program is highly unusual, and I would be skeptical.? There is a reason why most of the P&C Insurance industry does not offer Flood cover.? Severity of claims is very high when it happens.

I don’t like owning insurance companies at over 2x book, and this one is over 3x book.? Reserving seems a little weak, with a large reserve strengthening done in 2012.

Also, the share count is growing, which is a bad sign ordinarily, and particularly when capital is flush in the insurance industry, as it is today.? Asset growth is also a bad sign, from a quantitative standpoint.

If conditions are normalizing in Florida, the big guys will start to move back in, and HCI will lose a lot of its past advantages.

Taking concentrated risks is great for an insurance company, so long as no claim events occur.? But if there are severe claims from hurricanes, this company could be in a lot of trouble.? That’s why it has a high short interest.

And so my judgment is no interest.? Gun to the head, I would short it, but I don’t short, by and large.? This is another company with a limited strategy that could be washed up by a few major hurricanes in Florida.? We’re due.

On Position Sizing in Equity Long-Short Hedge Funds

On Position Sizing in Equity Long-Short Hedge Funds

Posted on by David Merkel

This article is prompted by the following article by John Hempton of Bronte Capital.? This is not meant as a criticism of him; I have nothing but respect for him.? The article triggered memories of my own experiences with position sizing at a hedge fund.

The hedge fund I once worked for had great expertise with financial companies, and I worked for them in the boom years of the 2000s.? Our leader was bearish on depositary financials, a view that would eventually be right.? Of course “eventually right” is another way to say “wrong in the short run.”

Let me describe the problem from another angle.? When I was a corporate bond manager, I would mentally set three levels with the bonds that I held.

  • Spread necessary for an ordinary-sized position.
  • Spread necessary for a big position.
  • Spread necessary for a maximum position.

These spreads I would adjust for premium vs discount, optionality, and a bunch of other things.? The point is that I would always have a schedule for where I would be willing to buy more, or lighten up (sell some).? I often dealt in some of the least liquid corporate bonds, and I was patient, and even willing to break rules by holding more than 20% of a given issue.? My analysts almost always did good work, and I trusted them.

When markets are illiquid, they “trade by appointment.”? If you have a balance sheet behind you that is not worried about liquidity, you can do interesting things by buying assets that most ordinary managers won’t touch, because the issue is too small.

I came to the hedge fund after I managed corporate bonds.? In one sense, I had managed a far more complex long-only portfolio.? But being able to short creates complexities of its own.

I can’t tell you how many times at meetings at the hedge fund we had tough discussion on position sizing, more frequently on short positions. We were perpetually long quality, short market capitalization, long insurers, short banks, and long value.? Great idea, if too early. This would be an extreme example:

Boss: “This short position is killing us, it is up 50% from where we shorted it, and now we have a 6% short position, what do we do?”

Others answered in front of me, essentially suggesting no change.? He asked me personally and I said:

David: “If you had no position, and you were approaching this company today, what would you do?”

Boss: “I would short the maximum — 4%.”

David: “Then buy in 2%.”

Boss: “But that locks in the loss.”

David: “Do you want to risk locking in a bigger loss?”

The boss once said to me that I was the only one on his team that was natively a portfolio manager rather than an analyst.? (That said, I remained an analyst, while an analyst was made an assistant portfolio manager.? I think it would have been too difficult to have the insurance guy to manage the portfolio of what was a banking shop.? That said, as a corporate bond manager, I managed the financials, which were mostly banks.)

Setting position sizes on shorts is always harder than longs.? When your thesis goes wrong on a short, your risk increases, as the position size gets larger.? When it goes wrong on a long position your risk decreases, as the position size gets smaller.

As I have often said, being short is not the opposite of being long, it is the opposite of being leveraged long.? When you are short, or leveraged long, you do not fully control your trade.? The margin desk can take you out of your trade if the equity in the account gets small enough.? They are ruthless in doing so, because the margin desks at brokerages do not want to take losses.

That makes it all the more important to set a schedule of sizes on short positions.? The first question should be: at what price would I put my maximum position on?? That would help in sizing introductory and normal positions.? They would be far smaller than what most hedge funds do.

Again, the same exercise is easier in a long-only format, but the protocol is the same.? Establish introductory, normal and maximum position sizes, and hold to them.? Also put into effect the idea that analysts must give greater scrutiny to large positions.

All That Said

This is a reason I am not a fan of most hedge funds.? I believe in the funds of my former employer and those of Mr. Hempton.? But the difficulties of dealing with bad decisions with a weak balance sheet kills a lot of hedge funds.? Long only — it might survive.? But when you go long and short with leverage, the risk arises of total loss.

So don’t think you are a “cool kid” because you invest in hedge funds.? Long only does better over the long haul, because it is less risky, and compounds value.

 

There are Limits to Valuations

There are Limits to Valuations

Posted on by David Merkel

Every now and then, some will argue that there are no limits on valuations.? This tends to happen in bull markets.? We are getting that now.

This sentiment is sometimes due to ignorance, because bull markets encourage cheerleaders.? There are few who will oppose a bull market, though many who will talk about it after the bear market emerges, as if they had predicted it.

But there are limits on valuations.? Think of the bankruptcy pecking order.

  • Government and lawyers get paid
  • General creditors get paid
  • Banks and secured bondholders get paid
  • Unsecured bondholders get paid
  • Preferred stockholders get paid
  • Common stockholders get paid

That is the way you should think about risk.? What are the odds that you do not get paid?? The higher the odds that you don’t get paid, the higher the yield you must receive.? Don’t own a stock unless you are likely to be earning significantly more then the preferred stock, much less debt instruments on the same company.

That is why I look at the value of various claims on a company.? It gives me data on where the stock should be valued.

I encourage all readers to think like businessmen about investments, because it leads to the best results.? Analyze where valuations are cheap, and where free cash flow is being productively deployed.

That is the way to think about investing.? Think like an intelligent businessman, and only buy companies that you would like to run.

On Value Investing

On Value Investing

Posted on by David Merkel

In general, over the years, I have had respect for John Buckingham, who writes The Prudent Speculator.? I caught this because we own the? same stock Ensco plc.? As he said:

For instance, Ensco PLC (ESV) is the world?s second largest offshore driller, operating in six continents with one of the newest jackup and deepwater fleets in the industry. The company has shown a relatively impressive ability to keep operating expenses in check and generate solid free cash flow, while the P/E is less than 10, the dividend payout is more than 5% and profits per share are expected to increase from $6.14 last year to $6.67 this year and $7.79 in 2015. In short, we find Ensco to be a high-yielding, value-priced, financially-strong growth stock, operating in an industry with high barriers to entry and favorable long-term demand characteristics!

Great minds think alike, and fools seldom differ.? You shouldn’t buy Ensco after reading this unless you have studied it out.? Just because I agree with a comrade does not mean you should take action.? We could both be wrong.

At the end of his piece he listed many summary statistics of his portfolio.? I want to compare his with mine:

Dividend yield: His: 2.3%, mine 2.2%

P/E: His 15.9x, mine 12.0x

P/B: His 1.65x, mine 1.48x

P/S His 0.86x, mine 0.68x

I don’t look for dividend yields, and many European stocks that I own pay dividends, just not regular dividends — the philosophy is different there.

One thing that is different for me versus Buckingham is that I have more foreign stocks in my portfolio.? I am willing to consider companies in countries that follow the rule of law.

I have done better, and you are free to ask me how.? My main idea is to search for the best ideas regardless of where they are domiciled, or what size they are.? I analyze stocks regardless of how they are categorized by most.

Full disclosure: long Ensco plc [ESV]

 

Good Over-the-Counter “Pink” Stocks

Good Over-the-Counter “Pink” Stocks

Posted on by David Merkel

I really appreciate my readers.? Here’s an e-mail from one:

David,

Just read your recent blog post ?E-mails on Insurance.?

You made the comment that ?aside from non-sponsored ADRs no good companies trade on the pink sheets.?

Of course that is true in a general sense. I also am sure you have been inundated with lots of email taking exception to that comment.

One company I have loosely followed over time (that I came across just by chance many years ago) is Computer Services (CSVI) [www.csiweb.com]. There is no volume in the stock so institutional managers have no ability to take a position, but the firm has done a great job of growing the business while maintaining profitability (been an opportunistic acquirer of small bank processor companies) and is probably a candidate for consolidation by a Fiserv or someone like that. Anyhow, I think if you take a look at the firm, you will see that there is at least one solid company traded on the pinks (and I am sure there are others, I just don?t go fishing there).

My comment ?aside from non-sponsored ADRs no good companies trade on the pink sheets.? is an overstatement.? To prove that, I give you a list of 148 companies that:

  • Have been profitable for the last four fiscal years.
  • Are US companies
  • Are not ADRs

2370 companies that trade over-the-counter reduce to 148 companies — 6.24% of the whole, explaining why my overstatement is largely, but not totally correct.? I would not tell someone to look amid these companies to find good ones, but there are some good ones there.? I have listed them in declining order of market capitalization.

Company Ticker Sector Industry Mkt Cap Dollar Volume P/E P/B P/S
Belk Inc BLKIA 09 – Services 0951 – Retail (Department & Discount) ?? 2,057.80 ??????????? – ?? 12.40 ???? 1.66 ???? 0.51
First National Bank Alaska FBAK 07 – Financial 0727 – Regional Banks ????? 604.00 ??????????? – ?? 14.90 ???? 1.23 ???? 5.45
First Citizens Bancorporation, FCBN 07 – Financial 0727 – Regional Banks ????? 572.70 ???? 33.20 ???? 9.60 ???? 0.64 ???? 1.87
Computer Services, Inc. CSVI 10 – Technology 1036 – Software & Programming ????? 476.10 ?? 146.81 ?? 18.20 ???? 3.80 ???? 2.31
Hills Bancorporation HBIA 07 – Financial 0727 – Regional Banks ????? 345.00 ?????? 3.65 ?? 13.30 ???? 1.29 ???? 4.03
Farmers & Merchants Bancorp FMCB 07 – Financial 0727 – Regional Banks ????? 324.40 ???? 20.85 ?? 13.60 ???? 1.54 ???? 4.27
FRMO Corp. FRMO 07 – Financial 0721 – Misc. Financial Services ????? 302.80 ???? 23.45 ?? 26.90 ???? 3.66 ?? 16.64
HomeFed Corporation HOFD 02 – Capital Goods 0215 – Construction Services ????? 299.80 ???? 22.83 ?? 62.40 ???? 1.79 ???? 7.93
First Opportunity Fund, Inc. FOFI 07 – Financial 0721 – Misc. Financial Services ????? 262.10 ?? 269.95 ???? 7.20 ???? 0.86 ?? 58.25
International Wire Group Holdi ITWG 01 – Basic Materials 0127 – Misc. Fabricated Products ????? 255.40 ?????? 2.61 ?? 19.60 ???? 6.69 ???? 0.21
Canandaigua National Corporati CNND 07 – Financial 0724 – Money Center Banks ????? 249.90 ?????? 6.65 ?? 12.20 ???? 1.66 ???? 3.41
Viskase Companies, Inc. VKSC 01 – Basic Materials 0109 – Containters & Packaging ????? 237.90 ?? 214.50 ?? 24.10 ???? 0.67
Conrad Industries, Inc. CNRD 11 – Transportation 1118 – Water Transportation ????? 226.80 ?? 249.58 ???? 9.10 ???? 1.95 ???? 0.86
United Capital Corp. UCAP 10 – Technology 1024 – Electronic Instruments & Controls ????? 187.40 ?????? 4.80 ?? 13.40 ???? 1.34 ???? 1.58
Isabella Bank Corp ISBA 07 – Financial 0727 – Regional Banks ????? 184.70 ???? 52.67 ?? 15.50 ???? 1.14 ???? 3.39
Profire Energy, Inc. PFIE 02 – Capital Goods 0209 – Construction – Supplies and Fixtures ????? 160.20 ???? 98.83 ?? 41.90 ?? 10.81 ???? 5.97
Cambridge Bancorp CATC 07 – Financial 0727 – Regional Banks ????? 150.50 ???? 59.33 ?? 11.50 ???? 1.47 ???? 3.20
Citizens Financial Services In CZFS 07 – Financial 0718 – Investment Services ????? 148.30 ???? 24.55 ?? 10.90 ???? 1.64 ???? 4.06
Mestek, Inc. MCCK 02 – Capital Goods 0218 – Misc. Capital Goods ????? 144.40 ?????? 0.86 ???? 8.80 ???? 1.03 ???? 0.41
Webco Industries, Inc. WEBC 01 – Basic Materials 0127 – Misc. Fabricated Products ????? 143.50 ???? 16.95 ?? 15.50 ???? 0.57 ???? 0.22
First Keystone Corp. FKYS 07 – Financial 0727 – Regional Banks ????? 137.80 ???? 18.75 ?? 12.80 ???? 1.42 ???? 4.32
MVB Financial Corp MVBF 07 – Financial 0724 – Money Center Banks ????? 135.30 ???? 14.40 ?? 22.10 ???? 1.67 ???? 5.34
First Mid-Illinois Bancshares, FMBH 07 – Financial 0727 – Regional Banks ????? 130.30 ?????? 4.40 ?? 12.90 ???? 1.32 ???? 2.43
First Real Estate Investment T FREVS 09 – Services 0933 – Real Estate Operations ????? 126.70 ???? 13.69 ?? 42.40 ???? 7.73 ???? 3.08
First Manitowoc Bancorp, Inc. BFNC 07 – Financial 0730 – S&Ls/Savings Banks ????? 120.80 ???? 33.30 ?? 11.30 ???? 1.19 ???? 3.07
Peoples Financial Services Cor PFIS 07 – Financial 0727 – Regional Banks ????? 120.40 ???? 62.40 ?? 14.60 ???? 1.90 ???? 4.37
First Farmers & Merchants Corp FFMH 07 – Financial 0727 – Regional Banks ? ????111.20 ?????? 3.30 ?? 13.30 ???? 1.05 ???? 3.05
Yasheng Group HERB 05 – Consumer Non-Cyclical 0509 – Crops ????? 105.50 ?????? 3.88 ???? 0.80 ???? 0.05 ???? 0.11
Farmers & Merchants Bancorp In FMAO 07 – Financial 0727 – Regional Banks ???? ?105.10 ???? 62.01 ?? 11.40 ???? 0.98 ???? 3.37
Nova Lifestyle Inc STVS 04 – Consumer Cyclical 0421 – Furniture & Fixtures ???????? 89.20 ???? 93.77 ?? 16.80 ???? 2.50 ???? 1.17
Golden Growers Coop GGROU 05 – Consumer Non-Cyclical 0509 – Crops ???????? 89.10 ?????? 1.44 ?? 18.50 ???? 2.30 ???? 0.93
First Guaranty Bancshares, Inc FGBI 07 – Financial 0727 – Regional Banks ???????? 88.20 ?????? 7.01 ?? 10.50 ???? 1.03 ???? 1.72
QNB Corp QNBC 07 – Financial 0730 – S&Ls/Savings Banks ??? ?????83.40 ???? 49.82 ???? 9.70 ???? 1.12 ???? 2.62
CCFNB Bancorp Inc CCFN 07 – Financial 0727 – Regional Banks ???????? 78.40 ???? 26.99 ?? 12.00 ???? 1.05 ???? 3.75
Calvin B. Taylor Bankshares, I TYCB 07 – Financial 0727 – Regional Banks ??? ?????75.70 ?????? 3.84 ?? 17.80 ???? 0.95 ???? 5.11
Juniata Valley Financial Corp JUVF 07 – Financial 0730 – S&Ls/Savings Banks ???????? 73.20 ?????? 7.85 ?? 18.80 ???? 1.50 ???? 4.35
Northwest Indiana Bancorp NWIN 07 – Financial 0730 – S&Ls/Savings Banks ???????? 72.70 ?????? 7.68 ???? 9.80 ???? 1.08 ???? 2.76
Franklin Financial Services Co FRAF 07 – Financial 0727 – Regional Banks ???????? 71.80 ???? 36.33 ?? 13.10 ???? 0.77 ???? 1.97
Rand Worldwide Inc RWWI 10 – Technology 1036 – Software & Programming ???????? 67.60 ???? 24.38 ?? 41.70 ???? 2.05 ???? 0.85
Centrix Bank & Trust CXBT 07 – Financial 0727 – Regional Banks ???????? 67.40 ?????? 7.17 ?? 12.00 ???? 1.29 ???? 2.26
Peoples Bancorp PBNI 07 – Financial 0730 – S&Ls/Savings Banks ???????? 66.80 ?????? 7.20 ?? 21.60 ???? 0.88 ???? 3.59
Reserve Petroleum Co RSRV 06 – Energy 0609 – Oil & Gas Operations ???????? 66.20 ???? 20.75 ?? 10.90 ???? 2.05 ???? 3.49
Harleysville Savings Financial HARL 07 – Financial 0730 – S&Ls/Savings Banks ???????? 65.60 ???? 19.95 ?? 13.90 ???? 1.10 ???? 2.09
William Penn Bancorp Inc WMPN 07 – Financial 0730 – S&Ls/Savings Banks ???????? 65.50 ???? 28.80 ?? 23.40 ???? 1.15 ???? 4.86
Kentucky Bancshares, Inc. KTYB 07 – Financial 0727 – Regional Banks ???????? 65.30 ?????? 6.00 ???? 9.10 ???? 0.92 ???? 2.36
Community Bancorp Vermont CMTV 07 – Financial 0727 – Regional Banks ???????? 64.50 ?????? 5.31 ?? 13.70 ???? 1.50 ???? 2.82
Hennessy Advisors Inc HNNA 07 – Financial 0718 – Investment Services ???????? 64.30 ?????? 9.81 ?? 13.10 ???? 2.23 ???? 2.74
Monarch Cement Co MCEM 02 – Capital Goods 0212 – Construction – Raw Materials ???????? 63.40 ???? 13.42 ?? 21.00 ???? 0.96 ???? 0.69
Armanino Foods Of Distinction AMNF 05 – Consumer Non-Cyclical 0515 – Food Processing ???????? 63.10 ???? 47.48 ?? 21.90 ???? 9.85 ???? 2.25
Q.E.P. Co., Inc. QEPC 02 – Capital Goods 0209 – Construction – Supplies and Fixtures ???????? 62.10 ???? 17.14 ???? 5.80 ???? 1.08 ???? 0.21
Commercial National Financial CNAF 07 – Financial 0727 – Regional Banks ???????? 60.10 ???? 17.85 ?? 12.10 ???? 1.33 ???? 4.17
Croghan Bancshares, Inc. CHBH 07 – Financial 0727 – Regional Banks ???????? 57.90 ?????? 8.63 ?? 12.80 ???? 0.86 ???? 2.72
Burnham Holdings Inc BURCA 02 – Capital Goods 0209 – Construction – Supplies and Fixtures ???????? 57.20 ?????? 6.66 ?? 12.80 ???? 1.29 ???? 0.42
Standard Financial Corp. STND 07 – Financial 0727 – Regional Banks ???????? 56.10 ???? 51.56 ?? 19.30 ???? 0.71 ???? 3.39
Choiceone Financial Services I COFS 07 – Financial 0727 – Regional Banks ???????? 54.90 ???? 13.34 ?? 11.30 ???? 0.90 ???? 2.85
LICT Corporation LICT 09 – Services 0915 – Communications Services ?????? ??54.00 ??????????? – ???? 6.70
Capital Properties Inc CPTP 09 – Services 0939 – Rental & Leasing ???????? 52.80 ?????? 4.80 ?? 34.80 ?? 34.78 ???? 6.86
Middlefield Banc Corp MBCN 07 – Financial 0727 – Regional Banks ???????? 52.70 ?? 101.40 ???? 8.10 ???? 1.00 ???? 1.87
CSB Bancorp Inc (Ohio) CSBB 07 – Financial 0730 – S&Ls/Savings Banks ???????? 52.00 ???? 20.90 ?? 10.10 ???? 1.00 ???? 2.49
Jeffersonville Bancorp JFBC 07 – Financial 0727 – Regional Banks ???????? 51.70 ???? 17.69 ?? 11.80 ???? 1.03 ???? 2.71
Georgia-Carolina Bancshares In GECR 07 – Financial 0727 – Regional Banks ???????? 51.70 ???? 59.45 ???? 7.80 ???? 0.90 ???? 2.78
PSB Holdings Inc (Wisconsin) PSBQ 07 – Financial 0727 – Regional Banks ???????? 50.60 ???? 10.72 ???? 8.30 ???? 0.90 ???? 1.86
Consumers Bancorp, Inc. CBKM 07 – Financial 0730 – S&Ls/Savings Banks ???????? 49.30 ?????? 2.72 ?? 14.00 ???? 1.33 ???? 2.86
Quality Products, Inc. QPDC 02 – Capital Goods 0218 – Misc. Capital Goods ? ???????47.70 ?????? 3.78 ???? 8.30 ???? 4.84 ???? 1.63
Northway Financial, Inc. NWYF 07 – Financial 0727 – Regional Banks ???????? 47.10 ???? 10.26 ???? 6.70 ???? 1.03 ???? 1.41
Granite Falls Energy LLC GFGY 01 – Basic Materials 0103 – Chemical Manufacturing ???????? 45.90 ??????????? – ?? 15.30
George Risk Industries Inc RSKIA 09 – Services 0972 – Security Systems & Services ???????? 45.20 ?????? 9.89 ?? 11.40 ???? 1.40 ???? 4.27
F&M Bank Corp FMBM 07 – Financial 0727 – Regional Banks ???????? 43.30 ???? 11.21 ???? 9.00 ???? 0.84 ???? 1.63
Southern Michigan Bancorp SOMC 07 – Financial 0727 – Regional Banks ???????? 42.50 ?????? 5.33 ???? 9.40 ???? 0.77 ???? 2.15
Noble Roman’s, Inc. NROM 09 – Services 0942 – Restaurants ???????? 42.30 ???? 69.62 ?? 30.90 ???? 3.28 ???? 5.63
Minden Bancorp Inc MDNB 07 – Financial 0730 – S&Ls/Savings Banks ???????? 41.60 ?????? 3.50 ?? 12.80 ???? 0.98 ???? 4.07
Surrey Bancorp SRYB 07 – Financial 0727 – Regional Banks ???????? 41.50 ?????? 4.68 ?? 16.50 ???? 1.36 ???? 3.91
Corning Natural Gas Holding Co CNIG 12 – Utilities 1206 – Natural Gas Utilities ???????? 40.20 ?????? 7.99 ?? 20.40 ???? 1.78 ???? 1.74
Pioneer Railcorp PRRR 11 – Transportation 1112 – Railroads ??? ?????37.00 ?????? 6.72 ?? 21.30 ???? 2.80 ???? 1.77
Ziegler Companies, Inc., The ZGCO 07 – Financial 0718 – Investment Services ???????? 35.70 ???? 27.00 ?? 17.60 ???? 1.10 ???? 0.45
XCel Brands Inc XELB 07 – Financial 0721 – Misc. Financial Services ???????? 35.60 ?????? 0.35 ???? 5.70 ???? 1.04 ???? 2.33
Security Federal Corporation ( SFDL 07 – Financial 0730 – S&Ls/Savings Banks ???????? 35.40 ?????? 8.42 ?? 13.20 ???? 0.63 ???? 1.14
Regency Affiliates Inc RAFI 12 – Utilities 1203 – Electric Utilities ???????? 33.90 ?????? 1.44 ???? 9.00 ???? 1.05
New Ulm Telecom Inc NULM 09 – Services 0915 – Communications Services ???????? 33.50 ?????? 5.90 ???? 8.90 ???? 0.59 ???? 0.90
Heritage Bankshares, Inc. HBKS 07 – Financial 0727 – Regional Banks ???????? 29.60 ?????? 8.45 ?? 14.10 ???? 1.00 ???? 2.79
Home Loan Financial Corporatio HLFN 07 – Financial 0730 – S&Ls/Savings Banks ???????? 29.50 ?????? 2.60 ???? 8.60 ???? 1.17 ???? 2.82
High Country Bancorp, Inc. HCBC 07 – Financial 0730 – S&Ls/Savings Banks ???????? 29.50 ?????? 9.90 ?? 15.20 ???? 1.24 ???? 3.15
Commercial Bancshares, Inc. \O CMOH 07 – Financial 0727 – Regional Banks ???????? 29.10 ???? 14.76 ?? 10.30 ???? 0.95 ???? 2.06
South Street Financial Corp. SSFC 07 – Financial 0730 – S&Ls/Savings Banks ???????? 28.70 ?? 121.25 ?? 28.50 ???? 1.05 ???? 2.29
CreditRiskMonitor.Com Inc CRMZ 10 – Technology 1018 – Computer Services ???????? 27.90 ?????? 1.75 ?? 87.50 ???? 6.48 ???? 2.38
Smtp Inc SMTPD 10 – Technology 1018 – Computer Services ???????? 25.80 ???? 27.23 ?? 20.60 ?? 15.57 ???? 4.46
West End Indiana Bancshares In WEIN 07 – Financial 0730 – S&Ls/Savings Banks ???????? 25.70 ?????? 7.40 ?? 18.30 ???? 0.80 ???? 2.10
Northeast Indiana Bancorp NIDB 07 – Financial 0730 – S&Ls/Savings Banks ???????? 25.50 ?????? 6.21 ???? 9.30 ???? 0.92 ???? 2.55
Summit Financial Services Grou SFNS 07 – Financial 0718 – Investment Services ???????? 25.20 ???? 23.80 ?? 15.40 ???? 2.51 ?? ??0.31
First Bancorp of Indiana, Inc. FBPI 07 – Financial 0730 – S&Ls/Savings Banks ???????? 24.90 ?????? 2.85 ?? 16.00 ???? 0.86 ???? 1.88
Spindletop Oil & Gas Co SPND 06 – Energy 0609 – Oil & Gas Operations ???????? 24.40 ?????? 3.17 ???? 7.30 ???? 1.28 ???? 1.89
Frederick County Bancorp (MD) FCBI 07 – Financial 0727 – Regional Banks ???????? 24.10 ?????? 7.20 ?? 15.80 ???? 0.91 ???? 1.90
Meritage Hospitality Group Inc MHGU 09 – Services 0942 – Restaurants ???????? 24.00 ?????? 3.26 ???? 6.60 ???? 2.35 ???? 0.21
Pinnacle Bankshares Corp PPBN 07 – Financial 0727 – Regional Banks ???????? 24.00 ?????? 7.95 ?? 17.90 ???? 0.85 ???? 1.54
CNB Financial Services Inc CBFC 07 – Financial 0727 – Regional Banks ???????? 23.60 ??????? ????- ?? 15.10 ???? 0.83 ???? 1.97
Investors Heritage Capital Cor IHRC 07 – Financial 0709 – Insurance (Life) ???????? 23.50 ?????? 8.28 ?? 11.70 ???? 0.44 ???? 0.29
Trans World Corporation TWOC 09 – Services 0912 – Casinos & Gaming ???????? 22.50 ?????? 3.32 ?? 12.80 ???? 0.53 ???? 0.63
Pinnacle Bancshares, Inc. PCLB 07 – Financial 0727 – Regional Banks ???????? 21.70 ?????? 4.46 ???? 9.10 ???? 0.82 ???? 2.33
FFW Corporation FFWC 07 – Financial 0730 – S&Ls/Savings Banks ???????? 21.40 ?????? 6.74 ???? 9.10 ???? 0.93 ???? 1.66
ASB Financial Corp. (OH) ASBN 07 – Financial 0730 – S&Ls/Savings Banks ???????? 20.70 ?????? 5.85 ?? 13.40 ???? 0.98 ???? 1.96
SBT Bancorp Inc SBTB 07 – Financial 0727 – Regional Banks ???????? 20.50 ???? 21.95 ?? 13.50 ???? 1.06 ???? 1.72
Seychelle Environmental Techno SYEV 02 – Capital Goods 0218 – Misc. Capital Goods ???????? 20.40 ???? 20.22 ?? 19.80 ???? 4.65 ???? 3.46
Great American Bancorp GTPS 07 – Financial 0727 – Regional Banks ???????? 19.80 ?????? 2.70 ?? 13.40 ???? 0.80 ???? 2.26
Sierra Monitor Corporation SRMC 10 – Technology 1030 – Scientific & Technical Instruments ???????? 19.70 ???? 12.68 ?? 15.00 ???? 2.41 ???? 1.10
Logansport Financial Corp. LOGN 07 – Financial 0724 – Money Center Banks ???????? 19.60 ?????? 2.50 ???? 9.00 ???? 0.86 ???? 2.30
Seneca-Cayuga Bancorp Inc SCAY 07 – Financial 0724 – Money Center Banks ???????? 19.60 ?????? 1.24 ???? 9.50 ???? 1.00 ???? 1.64
Micropac Industries, Inc. MPAD 10 – Technology 1033 – Semiconductors ???????? 18.90 ?????? 3.67 ?? 20.90 ???? 0.96 ???? 0.97
Texas Vanguard Oil Co TVOC 06 – Energy 0609 – Oil & Gas Operations ???????? 18.60 ?????? 1.31 ?? 22.60 ???? 1.40 ???? 3.04
Issuer Direct Corp ISDR 09 – Services 0909 – Business Services ???????? 18.30 ???? 46.92 ?? 20.90 ???? 7.19 ???? 3.26
Environmental Tectonics Corpor ETCC 02 – Capital Goods 0203 – Aerospace and Defense ???????? 17.90 ?????? 3.22 ?? 21.70 ???? 2.47 ???? 0.55
Wells Financial Corp. WEFP 07 – Financial 0730 – S&Ls/Savings Banks ???????? 17.80 ???? 13.50 ?? 13.60 ???? 0.67 ???? 1.99
Sono-Tek Corporation SOTK 02 – Capital Goods 0218 – Misc. Capital Goods ???????? 17.40 ???? 37.68 ?? 60.00 ???? 2.79 ???? 1.89
DynTek, Inc DYNE 10 – Technology 1036 – Software & Programming ???????? 17.00 ?????? 0.80 ???? 5.00 ???? 2.23 ???? 0.13
Riverview Financial Corporatio RIVE 07 – Financial 0727 – Regional Banks ???????? 16.90 ???? 12.81 ?? 12.00 ???? 0.63 ???? 1.30
Paradise, Inc. PARF 05 – Consumer Non-Cyclical 0515 – Food Processing ???????? 16.60 ?????? 3.20 ?? 18.80 ???? 0.78 ???? 0.66
Bank McKenney (VA) BOMK 07 – Financial 0727 – Regional Banks ???????? 16.60 ?????? 4.30 ???? 9.10 ???? 0.73 ???? 1.55
Quaint Oak Bancorp Inc QNTO 07 – Financial 0730 – S&Ls/Savings Banks ???????? 15.60 ???? 30.88 ?? 23.60 ???? 0.85 ???? 2.38
Greenville Federal Financial C GVFF 07 – Financial 0730 – S&Ls/Savings Banks ???????? 15.40 ?????? 2.20 ?? 17.50 ???? 0.82 ???? 2.55
BV Financial Inc BVFL 07 – Financial 0730 – S&Ls/Savings Banks ???????? 14.40 ?????? 1.20 ?? 30.00 ???? 1.15 ???? 2.49
Jaclyn, Inc. JCLY 04 – Consumer Cyclical 0403 – Apparel/Accessories ???????? 13.70 ?????? 2.70 ?? 15.40 ???? 0.62 ???? 0.08
OPT-Sciences Corp OPST 10 – Technology 1030 – Scientific & Technical Instruments ???????? 13.50 ?????? 1.74 ?? 12.90 ???? 1.05 ???? 2.04
Citizens Bancshares Corporatio CZBS 07 – Financial 0727 – Regional Banks ???????? 13.30 ?????? 1.94 ?? 11.40 ???? 0.40 ???? 1.02
Chino Commercial Bancorp (CA) CCBC 07 – Financial 0727 – Regional Banks ???????? 13.20 ?????? 2.39 ?? 19.20 ???? 1.45 ???? 3.09
IEH Corporation IEHC 10 – Technology 1024 – Electronic Instruments & Controls ???????? 12.10 ???? 20.74 ???? 8.50 ???? 1.26 ???? 0.82
ITEX Corporation ITEX 07 – Financial 0718 – Investment Services ???????? 11.60 ???? 15.20 ?? 10.50 ???? 0.88 ???? 0.72
Zynex Inc. ZYXI 08 – Health Care 0812 – Medical Equipment & Supplies ???????? 11.20 ?????? 9.67 ???? 1.20 ???? 0.39
Great Lakes Aviation, Ltd. GLUX 11 – Transportation 1106 – Airline ???????? 10.50 ?????? 8.07 ???? 0.27 ???? 0.08
Fairmount Bancorp Inc FMTB 07 – Financial 0727 – Regional Banks ?????????? 9.80 ?????? 1.01 ?? 49.40 ???? 0.70 ???? 2.58
Solitron Devices, Inc. SODI 10 – Technology 1033 – Semiconductors ?????????? 9.50 ???? 32.63 ?? 11.20 ???? 0.85 ???? 1.10
Repro-Med Systems, Inc. REPR 08 – Health Care 0812 – Medical Equipment & Supplies ?????????? 7.70 ?????? 3.80 ?? 21.00 ???? 1.62 ???? 0.96
Union Electric Company UELMO 12 – Utilities 1203 – Electric Utilities ?????????? 7.60 ?????? 4.70 ?? 25.40 ???? 2.39 ???? 2.78
Surge Components, Inc. SPRS 10 – Technology 1024 – Electronic Instruments & Controls ?????????? 7.50 ???? 10.84 ???? 4.10 ???? 0.74 ???? 0.32
Home Financial Bancorp HWEN 07 – Financial 0730 – S&Ls/Savings Banks ?????????? 7.50 ?????? 1.68 ?? 13.30 ???? 0.92 ???? 2.21
Alliance Distributors Holding, ADTR 10 – Technology 1015 – Computer Peripherals ?????????? 7.50 ?????? 2.70 ???? 5.70 ???? 1.31 ???? 0.11
Community Investors Bancorp In CIBN 07 – Financial 0730 – S&Ls/Savings Banks ?????????? 7.10 ?????? 6.48 ?? 73.60 ???? 0.57 ???? 1.15
M&F Bancorp, Inc. MFBP 07 – Financial 0727 – Regional Banks ?????????? 7.10 ?????? 4.38 ???? 0.30 ???? 0.65
China Industrial Steel Inc CDNN 01 – Basic Materials 0121 – Iron & Steel ?????????? 6.60 ?????? 1.38 ???? 4.50 ???? 0.03
FPB Financial Corp. FPBF 07 – Financial 0730 – S&Ls/Savings Banks ?????????? 5.20 ??????????? – ???? 8.90 ???? 0.97 ???? 1.78
NexCore Healthcare Capital Cor NXCR 08 – Health Care 0806 – Healthcare Facilities ?????????? 5.10 ?????? 0.02 ???? 2.00 ???? 0.45 ???? 0.37
Precision Auto Care PACI 09 – Services 0909 – Business Services ?????????? 5.00 ?????? 0.17 ???? 7.30 ???? 0.26 ???? 0.19
Scientific Industries, Inc. SCND 10 – Technology 1030 – Scientific & Technical Instruments ?????????? 4.80 ?????? 2.34 ?? 12.40 ???? 0.89 ???? 0.68
Tidelands Royalty Trust B TIRTZ 07 – Financial 0721 – Misc. Financial Services ?????????? 4.70 ?????? 9.01 ???? 9.20 ???? 7.91 ???? 6.73
Foxby Corp FXBY 07 – Financial 0721 – Misc. Financial Services ?????????? 4.70 ?????? 1.09 ???? 6.50 ???? 0.77 ?? 23.62
TNR Technical, Inc. TNRK 10 – Technology 1024 – Electronic Instruments & Controls ?????????? 3.80 ?????? 4.31 ?? 12.30 ???? 0.99 ???? 0.41
Information Analysis Incorpora IAIC 10 – Technology 1036 – Software & Programming ?????????? 2.40 ?????? 1.97 ???? 1.19 ???? 0.44
Microwave Filter Co., Inc MFCO 10 – Technology 1024 – Electronic Instruments & Controls ?????????? 1.70 ?????? 1.50 ???? 1.03 ???? 0.53
Bayou City Exploration, Inc. BYCX 06 – Energy 0609 – Oil & Gas Operations ?????????? 1.50 ?????? 0.81 ???? 2.70 ???? 0.73 ???? 0.44
Tongli Pharmaceuticals (USA) I TGLP 08 – Health Care 0803 – Biotechnology & Drugs ?????????? 0.90 ?????? 0.01 ???? 0.40 ???? 0.04 ???? 0.07

Lotsa little banks and tech companies.? Hey, I’m going to throw those with over $100 million of market cap into my next portfolio reshaping.? I’m still small enough as a manager to deal with small companies if they are well-managed.? This can bring me back to my microcap value days, where I invested 1992-1998.? Once I made an offer to buy more than 5% of a company, and I asked my bosses if they would have any problems if I had to make a 13F filing.? They gave me the go ahead; I made my offer and it was turned down.? Pity, because if it had worked, it would have been a great investment.

The table above is a beginning for due diligence.? I do not recommend any of the stocks there.? I do note that my reader’s stock is high on the list.

Some of these stocks could be good investments, but you would have to do the research to figure out which ones are good.? On the bright side, almost no one is analyzing these companies, so your analysis has more punch relative to company outsiders.? Insiders will still do better.

All that said, I suspect that these stocks will do well on average.

E-mails on Insurance

E-mails on Insurance

Posted on by David Merkel

Here we go.? E-mail #1:

You truly have one of the great blogs out there!

I was wondering, have you ever had to evaluate a company that had set up a captive insurance company to self insure? How did you get comfortable with it?

As an example, ZCL composites on the TSXV. I looked at them awhile back and disqualified it as I could not get comfortable with the environmental liability. They manufacture fuel storage tanks, so insurance is a large component of their cost of doing business.

If they did have a reputable outside insurer, you could at least count on the insurer for doing some audit work in their manufacturing and installation processes. But they have set up a captive, and self insure.?

So, how would you calculate whether they have enough reserves?

I threw the company in the too difficult pile and moved on, but it has irked me as I like them.

Good toss into the too difficult pile.? Environmental liabilities are difficult even for actuaries inside the insurance companies? to analyze.? Those of us outside have no chance.? I cannot validate reserves from outside, and particularly not on long-tail lines.? I will not invest in any insurer that has a large part of its underwriting in asbestos/environmental — it is too risky.

That aside, using a captive is a negative sign.? No one uses a captive, except to weaken reserving, taxation, or other rules.

Next e-mail:

David,

I stumbled across Gainsco, Inc. (OTCPK:GANS), a very small nonstandard auto insurer (you may be familiar). It’s trading around 0.6x book value, seems to be well capitalized, and has had OK growth barring FY2012. It also has a pretty impressive 12.5% dividend yield.

I guess my questions are:

1) Would you expect this trade at such a discount to book because: its nonstandard insurance, it’s on the pink sheets (not regularly filing with the SEC), it’s too small, or some combination or other reason?

2) given that its nonstandard, I assume it’s riskier? What’s the best way to determine whether the company is adequately reserved/capitalized? 24.5% equity / assets seems pretty conservative, but I suppose if they’re not adequately reserved that could be meaningless.

Thanks so much, look forward to hearing from you.

I have run across Gainsco in the past, when they were bigger, and I avoided them.? Subprime insurers tend to lose money on underwriting over time.? There is a kind of cycle where a few make money for a few years, and then competition surges, and more money is lost than was previously made.? From the time I started as a buyside analyst of insurance stocks in 2003, until now, no subprime insurer has made money for a buy-and-hold investor.

Aside from that, Gainsco has gone dark.? You can see financials at their website, but do you trust them?? Aside from nonsponsored ADRs no good companies trade on the pink sheets.

Margin of safety — this does not meet my safety requirements.

Final E-mail:

Hi David,

I really enjoy your blog.? Have seen the recent news surrounding AmTrust Financial (AFSI) and short sellers?? I’d like to hear the thoughts of an actuary on the company and specifically the items that GeoInvesting points to.? To me, their financial structure appears extremely (perhaps, unnecessarily) complicated.?

Yes, and they fail my test of having conservative reserves.? They have had to strengthen reserves on prior year’s business for the past three years.? That is a bad sign, and would keep me away.? I think GeoInvesting is correct here, but this is not an endorsement of them generally.

It is very rare that an insurer should be valued near 2x book value.? Though I am rarely so bold, this one strikes me as a short sale, if you can get the borrow with confidence.

 

Where to Find Data

Where to Find Data

Posted on by David Merkel

Here’s another letter from a reader:

Hi David,

I have been a long time reader of your blog but writing for the first time. To me a key part of the investment process for a generalist investor has to be a way to efficiently screen stocks to generate? investment ideas and also measure historical returns and fundametals for various industry groups under various economic conditions. I am curious as to what data sources you use in your own work for historical stock market and fundamental data? Do you pull this into your own database and do you use Excel or? a statistical package for any quantitative backtests for your screens?

In a previous job I used FactSet to pull historical monthly pricing and quarterly fundamental data for a universe of over 100 regulated utility stocks (both current and past public firms). I also taught myself a fair bit of statistics along the way including logistic regressions and discriminant analysis in order to backtest different models for identifying outperformers, dividend growth/cuts etc. Unfortunately I had to do this all in Excel, which made the whole process pretty painful right on from cleaning up outliers, sorting etc. I guess for simple queries of stock performance and tracking various fundamental metrics over time it would work touse Excel.

One motivation for asking is that I hope to one day become an investing blogger myself, and am wondering if there are low cost ways of accesing this kind of data. Additionally I am always interest in real world methods people follow to prune the thousands of possible stocks to invest in to a smaller more promising subset that people can invest more time analyzing on a fundamental basis. To me the hallmark of a successful investor is the willingness to unturn many investing stones until a promising idea is found.

I am a tightwad when it comes to paying up for data or software.? I use the following:

  • FRED
  • Yahoo Finance
  • Value Line via my local library
  • AAII Stock Investor (A screening package, but more than that)
  • The Wall Street Journal
  • Bloomberg.com
  • FINRA TRACE — bond data
  • Bureau of Labor Statistics
  • Federal Reserve (but not FRED)
  • Microsoft Excel
  • If I need to do something complex, I can use the open source statistics package R.

AAII Stock Investor and Value Line are my main screeners.? I pay $100/year for AAII, and nothing for Value Line.? Oh, my library gives me Morningstar for free as well.? Both subscriptions are very full, and very useful as well.

Now all that said, though it is important to be able to access the data, developing the ability to interpret it is far more important.? There can be too much rigor in trying to analyze quantitative data.? You need to identify the three most significant variables that affect the result being analyzed and focus on analyzing them.? Most investment questions can be analyzed through the three most important variables.

Though I do backtests occasionally, I am happier to stick with theory, and base my actions off that.? Backtests are fraught with all sorts of bias, and basically say that the future will be like the past, only more so.

It would be great to have Bloomberg, FactSet, and some off-the-shelf statistics/programming package that integrates with them.? But life is tough, and we don’t always have that luxury, so we have to seek out data on the cheap, and analyze it cheaply also.

That’s how I do it now, but if I get more clients, I will start paying up for data and software.

Why Great CEOs Look at their Stock Price Every Now and Then

Why Great CEOs Look at their Stock Price Every Now and Then

Posted on by David Merkel

I was doing my daily reading, when I bumped across the article, Why great CEOs ignore their stock price.? Yeah, I know it is the USA Today, so it has to be simplistic.? Most of the article is correct.? I am not in favor of short-termism, and much less managements managing only to maximize their compensation.

Back in July, I wrote a piece called The Stock Price Matters, Regardless.? Though the whole piece is good, let me give you one quotation from it:

If management/board thinks the price of the stock is undervalued, they will be among those buying shares in the secondary market, improving the value of the shares for the remaining shareholders.

If management/board thinks the price of the stock is overvalued, they may look at other companies to buy that are reasonably priced or cheap that will make their firm more useful.? At that point, their stock is a useful currency for acquisitions.

There is a lot of value that can be derived from the current stock price, to a management team that is focused on creating value.? Buying back stock when it is cheap, and issuing stock to strategically acquire companies cheaply are important ways of creating value for shareholders.

Part of the job of an investment analyst is to analyze the management team and see if they are managing for themselves or for shareholders.? If they don’t use free cash flow well, it is not a good company to own.

One more problem of the USA Today article is that most large investments by corporations tend to do badly, whereas small investments tend to do well.? Management teams need to be careful about investing, and ask whether the investments are worth the risk.

Though there are innovative companies that have promising opportunities, such that they do not pay dividends or buy back stock, that’s not true of most corporations — reinvestment opportunities are limited.

It’s wrong to look at a bunch of special companies, and assume that all companies can do the same thing.? What I insist from the companies that I own is that they follow portfolio rule six.

Analyze the use of cash flow by management, to avoid companies that invest or buy back their stock when it dilutes value, and purchase those that enhance value through intelligent buybacks and investment.

Not all corporate investment is good.? Think of the long-term oriented managements in Japan back in the late ’80s.? At that time I thought, “How can accepting low returns on equity be a bright idea?”? There is always the possibility of wasting money via overinvestment.

I look for intelligence in the management teams in stocks that I own, and am quick to sell those that destroy value through bad investments, or bad buybacks.? I try to think like a businessman in all that I do as an investor.? It leads to good results.? As Buffett said,

?I am a better investor because I am a businessman, and a better businessman because I am an investor.?

Don’t look for simple metrics to analyze investments.? Embrace complexity, and realize that you have to consider how management teams use their free cash, whether to reward investors, or invest for the future, hopefully in productive ways.

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