Home
Previous
Next

December, 2004: 1 6 13 20 28 31

Disclaimer - IMPORTANT - Read this first!

Investor's Journal is a diary focused strictly on investments and personal finance issues, primarily from a contrarian and retiree point of view. Follow along with an average guy's failures and successes as he learns, by trial and error, the fine art of value investing.

With a year-end minimum target of $304,000, our combined equities' book value stands now at $327,900. The nest egg's total equities' price to book value is 1.4, vs. about 3.0 for the market as a whole.

Over the years, a number of good value bargains have been cited in Investor's Journal. Several of them were up considerably last year. 2004 too has seen its share of suggested assets realizing much of their price to value potential. This week alone witnessed stellar performances from:

For the 10/4/04 (inception) through the present competition between the Leapin' Lizards vs. Classic Value portfolios, as of the close of business 11/30, the Leapin' Lizards were ahead, with an appreciation of 4.8%. Classic Value was up 4.4%. (The S&P 500 Index, since 10/4, has risen 3.4%.)

Our five finalists this time, the favorite to be added to the Leapin' Lizards tracking portfolio as of early trading this morning, are: AGYS, HUBG, MTLM, PHS, and USG.

My choice among them is Agilysys, Inc. (AGYS) (recent price $16.53). AGYS has a market-cap of $532 million, a price to sales ratio of .34, a small dividend (.7%) with a low payout ratio (14%), a below average price to book ratio (1.68), a price to net working capital also below average (2.83), a return on equity of 7.5%, a high current ratio of 2.07, and low debt to equity of 0.13. The P/E is somewhat high, at 23. AGYS has appreciated 49% year to date and 52%, relative to the S&P 500 Index, in the last 52 weeks.

12/6/04-While gratified by the performance of some low price to book value assets last week (see Investor's Journal 12/1/04), I was curious what would be the average return of such purchases since a decision in 2002 to focus on raising the equity book value of our nest egg.

Not all assets mentioned here have been purchased for our own portfolio, but a majority of those cited with a price to book value ratio of .66 or below (one of the basic Benjamin Graham value criteria) were bought. So, to determine their overall appreciation, I collected the records of these transactions and worked out the individual asset and then the group gains vs. losses, how long each issue had been held, what criteria were used in selecting them, other characteristics they had at the time of purchase, etc.

There have been a total of 26 low price to book value additions to our securities since mid-2002. The returns ranged from a 100% loss (TSFT) to a 200% gain (MGPI). The mean time an asset was held (including 9 that are still part of the retirement portfolio) turns out to have been just 9 months. On average, not including commissions or dividends, even with losses for 15% of the stocks, on the whole these bargain equities appreciated 45.6% (which, if my math is right, is a 64.9% annualized compound appreciation).

Next, I wondered if there were any distinguishing features of the assets that performed least well, best, or in the mid-range.

The lowest performing 9 (out of the 26 total) low P/BK purchases, as a group, more likely:

• met just one Benjamin Graham safety criterion at the time of purchase (7 of the 9); and/or
• had no dividend at the time of purchase (5 of the 9).

On average, these underachievers had an 11.3% loss during the 7 month mean period they were held. (I'm actually surprised myself that the losses were this low for the worst performing group and that the losing stocks, altogether, were only 15% of the total low price to book value assets bought in the last two and a half years.)

Another finding contrary to expectations: I had thought that quite low-priced (penny stock) assets should be avoided, after TSFT had dropped to zero, but several that were bought as fairly low-priced stocks in our portfolio have done very well. Therefore, I now think it alright to occasionally invest in them if well protected in other ways, i.e. with a good margin of safety.

The best performing 9, as a group, more likely:

• met a price to sales ratio criterion of .5 or below (as did 5 of the 9);
• met at least 2 of the Ben Graham value criteria (8 of the 9);
• met at least 2 of the Graham safety criteria (6 of the 9); and/or
• had a dividend (and low dividend payout ratio) at the time of purchase (5 of the 9).

These super achievers were all up and averaged 123% gains over the 9 month mean period they were held (a compound annualized gain of 191%, which assumes that the initial amount and all gains are reinvested in the same type assets for the last three months of a one year investing duration, and that their performance in those extra months equals that in the first 9). This kind of result, and knowing the characteristics of stocks that achieved it, almost makes me yearn for a new bear market!

Performers in the mid-range all had gains, with increases (through the mean 11 months they were held) from as low as 8% to as high as 52%, for a group appreciation of 23%.

Assets in this category, as one might expect, are something of a mixed bag:

• 4 of the 8 met just one Benjamin Graham basic value criterion (price to book value .66 or below), yet these were up 31% on average;
• 4 of them met at least 2 Graham value criteria, but together these were up only 14%;
• all 8 of them met just one Graham safety criterion (debt to equity .99 or below; in fact all had a D/E of .33 or less);
• 4 of them had a dividend (with a low dividend payout ratio [.5 or below]), and these were up 34% (not counting the dividend income);
• 4 had no dividend, with a mean gain of just 12%.

At least based on this small sample, it seems that a company's well funded dividend is more important for better returns, among low price to book value stocks, than meeting more than one Graham value criterion.

If super achiever low P/BK assets are not available, a "pretty good" formula for low price to book value bargains would appear to be ones that have at least:

• a price to book value .66 or below (met by all the low price to book assets in the 26 asset sample);
• a debt to equity ratio of .33 or below (also a criterion met by all the stocks in the overall sample); and
• some dividend (with a .5 or below payout ratio).

There were 12 stocks meeting these three minimum criteria among the 26 purchases. They have had an average appreciation to date of 64%, with an average holding period (like the mid-range stocks) of 11 months (hence a compound annualized appreciation of 72%).

When assets with them are available, to the above minimum "pretty good" criteria these additional super achiever parameters may be worth adding to one's stock selection standards:

• an earnings yield twice the Aaa corp. bond yield;
• a price to sales ratio .5 or below;
• a price to net working capital less than 1;
• a current ratio of 2 or above;
• a low price to (positive) free cash flow.

At present, unfortunately, I can find no stocks that meet most of these extra low P/BK super achiever standards. However, there are a few from which to choose, that at least meet the above "pretty good" formula: CFNB, KINV, OTL, PNX, and TNT. (These will serve as my final five, for selection and addition of a favorite to the Classic Value portfolio this week, at tomorrow's early trading market price).

Note that stocks are now generally overvalued in my view. Certainly, there are far fewer bargains than there were in the fall of 2002, for instance. Thus there is a scarcity of current potential super achievers, and a relatively poor quality to even the few "pretty good" low P/BK stocks one can find. As such, I would be quite surprised if the returns over the next couple years match those above.

On the other hand, if, over the long-term, the best low P/BK bargains I can find do even ¼ as well per year as the "pretty good" formula ones have done since mid-2002, we should have no trouble beating the S&P 500 Index and at least doubling a portion of our investments every five years.

In the latest Classic Value vs. Leapin' Lizards competition, the Leapin' Lizards portfolio is ahead, with a 6.0% gain, while the Classic Value stocks are up 5.2%. (The S&P 500 Index, since 10/4/04, has appreciated 5.1%.)

Our favorite this time is Octel Corp (OTL) (recent price $20.57), which has a micro-cap market capitalization of about $258 million, a price to book value of only .56, debt to equity of 0.33, a small dividend (.54%) with a low payout ratio (2.19%), a trailing earnings P/E of 8.01 (with a projected forward P/E of 5.4), a price to sales ratio of 0.55, a return on equity of 7.65%, a current ratio of 1.29, and a price to cash flow of 4.88 (but a negative price to free cash flow). As Octel Corp's ratios indicate, this is not a great company, and it has problems. But if there are positive surprises ahead, the market, as typically happens sooner or later with value stocks, may overreact by driving its price up. If the asset's price rises to its book value, and assuming the latter remains essentially at or above its current level, the investor could see a profit of about 79%, with a target selling price of around $36.73. (Though stocks do not generally remain very long significantly below their book value, there are, however, no guarantees this or any security would rise in price or, indeed, that it would not fall dramatically.)

While I am still finding assets I can comfortably recommend to others and purchase for our own holdings, there are fewer available that have not already been mentioned, since this little Classic Value vs. Leapin' Lizards competition began a couple months ago, than when it was started. Ideally, market conditions would keep providing sufficient good bargains to add one to each portfolio about every other week, indefinitely into the future. But if this turns out not to be the case, I shall, once there are at least ten different holdings in each group, recommend again some still attractive assets already in one or the other portfolio, for purchase of additional shares, rather than reducing the overall potential or safety of the portfolios by accepting other issues of lower than desired quality.

12/13/04-In our Leapin' Lizards vs. Classic Value portfolio competition, since 10/4/04, the Leapin' Lizards are currently ahead, having gained 7.20%, while the Classic Value assets are up 4.11%. The S&P 500 Index in this period is up 5.92%. (In each case, dividends have not been included. However, commissions in the competing portfolios were factored in.)

This week, we are adding to the Leapin' Lizards tracking portfolio. The five finalists for possible selection were: CULS, FRD, HEMA, HUBG, and ZONS.

My choice among them is Friedman Inds. (FRD) (recent price $7.86). As usual, we'll add shares to the portfolio based on tomorrow's early trading market price. FRD has appreciated 131% year to date and has also gone up 138% in the last 52 weeks, relative to the S&P 500 Index. Yet its P/E is still below average, at 11.31. Its price to sales ratio is only 0.38. The price to book value is 1.67. FRD's price to free cash flow is just 2.77. Return on equity is 16.21%. The current ratio is a hefty 2.98, while long-term debt to equity is 0.00. The company's stock sports a great dividend of 4.12%, competitive with ten year treasuries, and the dividend payout ratio is reasonable at 23.94%. FRD's market cap puts it in the nano-cap range, at $59.70 million.

12/20/04-As of late last week, our nest egg before expenses was up 55% since the October, 2002 lows (the farthest down our portfolio had gotten in the latest bear market). Even after all expenses, we are ahead by 40% from that nadir.

In the Classic Value vs. Leapin' Lizards competition, the Leapin' Lizards are way ahead, with gains of 12.14% vs. a stodgy appreciation of 4.56% for Classic Value. (The S&P 500, since the competition's 10/4/04 inception, has risen 5.6%.)

The final five Classic Value candidates this week are: CSLMF, INFO, TAIT, TALK, and USG.

Our favorite is Taitron Components, Inc. (TAIT) (recent price $2.43). This is a nano-cap stock with a market-capitalization of $13.27 million. Its price to net working capital, if my figures are correct, is only 0.60. The price to book value is 0.56. Debt to equity is 0.06. The current ratio is 16.55. The company is in some distress and has negative earnings through the most recent reporting period. However, given its high net asset value in relation to price, TAIT appears to have good investment potential. In addition, management indicates it will continue a policy of enhancing shareholder value by purchasing shares. While this particular stock may not do well, historically portfolios of such holdings have performed better than the market averages.

12/28/04- The "Investor's Journal" entries this week will be in two parts, first this one, dealing with the Classic Value vs. Leapin' Lizards portfolio competition and then, on 12/31 or 1/1, one for a 2004 year-end summary.

The Leapin' Lizards continue to trounce both Classic Value and the S&P 500 Index, with a 14.91% gain since our 10/4/04 competition inception. Classic Value is ahead just 4.96%, while the S&P 500 Index, in the same period, has appreciated 7.24% through today's markets' close. (The portfolio gains are after purchase commissions, but do not include any dividends. The S&P 500 indicated record is also without dividends.)

The next competition selection will be added at tomorrow's early trading market price to the Leapin' Lizards tracking portfolio. The five finalist securities, each with a price to sales ratio of .5 or below, debt to equity of .33 or less, and a 50% or greater 52-week performance relative to the S&P 500, are: CULS, HEMA, INMD, USG, and ZONS.

My favorite among them is HemaCare Corp. (HEMA) (recent price $1.45). This company's stock has a nano-cap market capitalization of $11.58 million. Its trailing price to earnings ratio is still nicely low, at 7.92, although the stock is ahead 60% year-to-date and 54% in the last 52 weeks relative to the S&P 500 Index. HEMA has a positive free cash flow, a price to sales ratio of only 0.37, a below average (2.06) price to book value, a return on equity of 38.44%, and no dividend, but a healthy current ratio (1.77), and a reasonable debt to equity ratio (0.22).

I've noted that some popular investment services have lately been touting recent records, citing a few (of their many) recommendations that have performed quite well in just the last few weeks or days. Of course, generally one must pay to receive their suggestions, and the good news they are proclaiming would be significantly tempered (as is my own) if all endorsed assets' returns were averaged in.

Still, not to be completely outdone, we also have the favorable happenstance that a number of our mentioned equities have been up significantly in a short time. For instance, on 11/24/04 I indicated interest in INMD, then at a closing price of $6.90. It has since risen to close to $13, and though currently it is back down to $11.08, this is still a nearly 61% increase in only a little over a month. And, on 12/20/04, I indicated FRD as a favorite Leapin' Lizards selection. It was $7.86 then and now, just two weeks later, its market price is $11.39, a gain of almost 45%.

I have come across another excellent value investing site, this one focusing particularly on strategies with the Toronto, Canada, stock exchange: Stingy Investor.

12/31/04-Today marks my third anniversary of retirement. In financial terms, this has been a turbulent and harrowing period. We have experienced the worst equities bear market in close to thirty years, the aftermath of the 9/11 terrorist shocks, a near collapse of our airline industry, drug scares affecting the pharmaceutical industry, corporate scandals, accounting scandals, mutual fund scandals, insurance industry scandals, a loss in value of the US dollar of greater than 50%, a mushrooming of the trade deficit, a ballooning of the federal debt and of annual budget deficits, a major rise in personal and corporate indebtedness, higher commodity prices (particularly so for oil), a recession, an apparent quagmire or civil war developing in Iraq, the beginning of a rise in the federal funds rate, and perhaps the most devastating natural disaster in modern times.

Happily, a value investing approach to the management of Fran's and my retirement nest egg has so far seen us through such difficulties. As of the close of trading today, our net asset value, even after all expenses, is up 19.3%, since 12/31/01, and 8.1%, since 12/31/03. That works out to a compound annual increase of 6.0% for the last three years. (Before expenses - that required our use of principle or dividend resources - our nest egg would have been up 38.9% since 12/31/01 [or 14.6% since 12/31/03] and thus a compound annual return of 11.6% since I retired.) The overall portfolio gains were in spite of having roughly 25% of our assets in low performing reserves, non-liquid real estate, and bond assets.

Our total equity book value stands today at $335,000, well above the 2004 year-end target of $304,000 and already approaching the 2005 target of $342,000. We are intending a minimum annual book value increase of 12.5%, net of all expenses. Since assets generally trade above their book value levels, this should give an adequate margin of safety for most eventualities. Our all-equities price to book value ratio is now about 1.4 (vs. about 3.0 for the S&P 500 Index). If we can keep our equity book value each year at least $20,000 above (earlier) targets, we ought to be able to maintain a quite defensive P/Bk ratio, while also avoiding living past our assets.

The approach that worked least well for us this past year was the Unemotional Value Two (UV2) strategy. Per its indicators, we invested nearly $38,000, half and half, in SBC and T at the end of last year (and sold our holdings in HON and JPM). But they have not done well, netting us together only about 2.2%, including dividends. A mistake I made a year ago was to forget the criterion that worked well for me in late December, 2002, to assure that my selections for this method also had a price to book value ratio of 2.0 or below. It looks like neither SBC nor T would have qualified using that P/Bk screen. It might have been better to have just delayed a purchase till low price to book UV2 stocks could have been found.

The current Unemotional Value Two selections, if my calculations are correct, look to be SBC, again, plus PFE. However, neither of these meets the additional P/Bk 2 (or below) standard. So, rather than going with other than UV2 Dow stocks that have relatively low prices, high dividends, and low P/Bk, such as GM or JPM, since I now know of strategies with excellent potential and generally more reliable records I am suspending further investing in the UV2 technique, pleased though that, on average, even with my mistake last year, it has provided about a 59% total return since 12/31/02, an annual compound rate of about 26%.

The Benchmark Investing approach has worked better for me in 2004 than last year, when my return was only a little over 6% (over roughly half a year). Even with significant losses in the past several months on earlier BI selections MRK and PFE, after combining S & P 500 Index BI stocks (including HD [at one time our largest holding] and HDI) and carefully chosen Mid-Cap 400 BI selections (such as BKS, CREE, MACR, POS, TSN, CYTC, and GVA), my overall BI total return has been about 30% for 2004.

Once more this year, my best performing strategy has been to purchase classic Benjamin Graham type assets, selling at a significant discount to true value, calculated using simple ratios such as dividend 2/3 or greater the Aaa corporate bond yield, price to net working capital .66 or below, price to book value also .66 or below, or an earnings yield at least twice the Aaa corporate bond yield, all with debt to equity .33 or below and dividend payout ratio (if there is a dividend) .5 or below. At a total return of around 35% in 2004, this strategy did not do nearly as well as last year, when annualized gains from these assets were roughly 80%. However, I am not complaining!

A promising new method still in the experimental phase is my Leapin' Lizards approach, begun only on 10/4/04, in which I buy assets with price to sales revenue .5 or below, debt to equity .33 or below, 50% or greater gains, vs. the S&P 500 Index, in the last 52 weeks, and at least one other statistical criterion in its favor (ideally also with one or more B. Graham value criteria met). Since inception, this approach is now ahead slightly more than 12%. (If this could be sustained [a big condition!], compound annualized gains would be roughly 62%, but of course that is very unlikely.)

A substantial percentage of our holdings are in long-term stocks, such as BRK/B, L, and HAN, or in equity mutual funds. Though they still seem to have good potential, these lately have performed (overall) only about as well as the major market averages, but serve now more as ballast and diversification holdings than "engines of growth."

For the coming year, we aim to still balance risk aversion with a rather mechanical selection of assets that meet certain proven statistical criteria, while keeping debts and spending low.

As mentioned at the opening of this entry, there are many concerns now about the nation's or even the globe's economic health. I can see, for instance, that great havoc could yet be done by those who would continue spending much more than our country has in revenues, or by others who wish to greatly wound or bring down the US or to disrupt the world's efficiently functioning system of finance. Over the long-term, though, it seems reasonable, as Graham, Templeton, and others have noted, that the approach of buying assets at around .4 to .8 on the dollar (or Euro, Yen, etc.) and selling them at 1.0 to 1.2 or so, will in the end prove worthwhile. I'll try to put my focus on the latter opportunities rather than on the former challenges.

Home | Previous | Next