When is enough enough? Research and the curious case of Bozzutos

In many ways I'm both party to and perplexed by the desire to research to death consumer purchases. Looking for a new set of wrenches?  There is someone out there who's written an exhaustive online review of popular wrench sets.  The review might contain things like "the handle wasn't as solid as I would have liked." or "the jaws didn't slide as easily as xyz brand's did."  And it's at this point that suddenly as a consumer you have doubts about a product.  Did you know jaws on wrenches slide differently, or the metal forging process different between brands and that someday, somehow that might be important?  If you didn't you know now, and you're now paranoid you'll purchase a dud when you finally decide to "invest in a wrench", because everything you spend money on these days is an "investment."

I almost can't help myself from reading online reviews.  The detail and descriptions of everyday products by everyday people is fascinating.  Who knew a pair of jeans could change someone's life, or that someone searched for years for just the right backpack?  Prior to the Internet everyone went to a local store (or used a catalog) and purchased what was available.  If there were three wrenches they fell into a general pattern.  There would be a cheap one, a middle grade one and an expensive one.  My dad taught me that the middle quality level product was always the one to buy.  Why? I don't know, but I've heeded his advice since.

The review/research explosion was perfectly timed with the explosion of super computers in people's pockets, or shall we call them smartphones.  In the past if I wanted a rare craft beer I'd have to read about them, write down the names and then see if they were in stock at the local store.  Sometimes I'd drive to a number of stores, or make a series of phone calls and give up.  Now I can go without any prior knowledge of what I want and look up reviews on the spot determining the best of what's available.  This isn't just craft beer, it's vacuum cleaners, pots and pans, cars, anything and everything.  We've become a nation of critics on the finer points of meaninglessness.

This same phenomenon has carried through to stocks.  Investors have become so unsure of themselves that they now reference the 'reviewers.'  "Oh my stock has abc guru invested in it." or "I heard this was pitched at some conference." All of these are shortcuts are ways to reaffirm to ourselves that we've made a good pick.  Maybe some of this stems from the lack of defined processes for individuals, but I think a lot of it is due to the review culture.  If people are blogging about gold toe socks and reading sock reviews in a store it would only make sense that the'd hesitate before purchasing something bigger, such as shares in a company.

Information is just that, a set of numbers or facts or details that describe something.  Information by itself is mostly meaningless.  I can tell you the dimensions of the shed in my backyard, the material it was made out of and variety of precise details.  But it doesn't matter.  You don't care about my shed, I don't really even care about my shed.  It serves a purpose, to hold kid toys, a lawnmower and garden equipment.  The shed's purpose gives meaning to the information about it.  If the purpose is to hold a lawnmower and the shed is too small it won't be able to fulfill it's purpose.

More information about something isn't always better, sometimes it's worse.  Sometimes the minutia of information blinds us from seeing what's really important.  A key skill for an investor is to research a company up to the point of diminishing returns, but not any further.  Anything past the point of diminishing returns is wasted time.  Although I should point out, investors do seem to like wasting time, because there is a feeling of doing something.

I love to invest in stocks that report financials once a year, or maybe twice a year.  For someone who's addicted to the minute by minute ticks of the market this must seem like insanity.  But I don't care about daily ticks, or weekly ticks, or even monthly ticks.  My first rule of investing is to look for a margin of safety, downside protection and the confidence that a company I own isn't going to disappear between my yearly statements.  If I'm comfortable that the business will continue as usual why do I need to check in hourly/daily/monthly how things are going?  Imagine being the part owner of an burger joint and hiring someone to run the place.  Then calling up your partner hourly and asking "how's business right now?"  "Is it slow, is it fast?"  You'd go insane.  In the morning you'd be worried about how slow it is, and at lunch and dinner you'd be patting yourself on the back for how successful your restaurant is.  This seems like a silly analogy, but if you look online people are starved for information, even a steady drip of meaningless information is like water to a thirsty soul.

The successful investor is one who can identify the steady drip of information as meaningless and focus on what's truly important.

When a company doesn't report financials often it's easy to keep the forest in mind rather than focusing on the trees.  Even focusing on the trees would be progress for some investors. There are investors who are looking at branches and tiny pieces of bark wondering what their greater meaning is, but I digress.

That brings us to Buzzutos, a grocery store distributor and grocery store operator in New England.  The company has the potential to trade, and I say that loosely.  Shares are by appointment, although I was able to snag a few when there was a seller a few years ago.  I purchased the shares based on a tip, and by tip I mean someone sent me their annual report.  I realized that the gap between the market value and what they were worth was fairly sizable.  I also like to lock my money up for years with no return and this seemed opportune, of course on that point I kid, but only slightly.

The company is mainly a distributor, and distributors make the smallest margin in the world.  In 2013 the company reported $1.8b in revenue and $420k in net income.  This is down dramatically from the $5.8m they earned on $1.7b in revenue in 2012.  It's worth noting that if the CEO didn't pay himself $5m that shareholders would be looking at a lot more net income.  This is nothing more than a private company disguised as something public with a tiny float.

The CEO and a relative own 70% of the stock.  There is a company ESOP that controls another 16% of the company's stock.  The company has a 14% free float, not much at all.  This is also why shares never trade.

The attraction for the company is they have a $20m market cap with a book value of $37m or so (as of 2013).  They trade for a significant discount to book, and when they were earning $5m a year they were trading for 4x earnings.  A company at 4x earnings and 54% of book value is my type of investment, even if I have to sit and wait for years for something to happen.  It's also worth pointing out that in 2012 the company generated $15m in operating cash flow, that's almost their market cap thrown off in cash in a single year.  There are a few other items that combined made this potentially attractive.  The company uses LIFO accounting and if they used FIFO like the rest of the world their assets and corresponding book value would be $28m higher.  Suddenly this is a $65m stock trading for $20m, or 30% of book value. The last item of note is that the company owns 50% of the Better Val-U grocery store chain that's held on the books at $900k, it's original cost.  Better Val-U earned $15m in revenue in 2013, if there was profit it was probably washed away into management's coffers.

I'm a sucker for these dead end stocks.  I picked up a few shares and had forgotten about them in the corner of my portfolio.  There is a lot of hair on this stock, and I mean a lot, we're talking Chewbacca levels of hair.  The CEO is basically picking shareholder pockets with a ton of related party transactions, and one-sided agreements to enrich management.  If there's something egregious that management can do to take advantage of shareholders it's probably in their annual report.  I'm not going to even add up all of the related party stuff, it's sickening.  From a quick glance management is pulling $20-30m out of the company a year.  This could be a profitable company, but management has decided against it, it is personally profitable for themselves.

At this point in this post you're probably confused.  How did I start talking about research and end up talking about management's highway robbery of Bozzutos?  The missing link is a piece of mail I received yesterday.  A fund sent a tender offer circular  to me via my broker to buy my shares in an offer for 40,000 total shares.  The offer is at a very slight premium, but not worth trying to take advantage of.

This is where my research antenna went up.  Why is a fund trying to buy almost all of the available float of a tightly held company?  What's the motive here?  Activism is most successful when management owns a minority of a company's shares, not almost every last one.

The first instinct of most shareholders who receive the circular will be to sell their shares to the fund, and I think that's probably a good idea.  The activist fund is providing liquidity, they're offering a fair price, and they can afford to buy out almost everyone.  But I'm not everyone, I'm thinking about this differently.  Once the shareholder base is management, a hedge fund and a few stubborn souls like myself what will happen?  Will this fund petition the company to buy out everyone else?  Will they sue management and arrange a settlement?  Whatever it is it would have to be at a premium to the offer price.  And my cost basis is right around there.  So in a sense I have almost nothing to lose by holding.

This is also where my points about the minimum threshold of research apply as well.  One doesn't need to drive around New England checking out grocery stores and distribution centers.  One also doesn't need to spend much time looking at the annual report.  This is a company with a lot of revenue where much of the revenue is siphoned off to management.  But if management were forced to cut their pay 10% that would be an enormous payout for shareholders in the form of increased net income.

At current prices (if you can get shares, and it's doubtful you can) Bozzutos offers investors a lot of optionality.  At worst shares continue to do what they've done for years, absolutely nothing.  But with someone stirring the pot there's no hope that maybe something else might happen.  Maybe we'll be bought out at book value.  I wouldn't mind a 2.5-3x return on this.  And a return like that annualized even over a long time is still attractive.  That's one of the reasons I get into stocks like this.  Flat for years then a 3x return is significant.

So what now?  Nothing really.  I'm not doing anything, I'm just going to continue to wait and see what happens.  I think shareholders who want liquidity should get out, and everyone else should sit around and see what happens.

The SFB Bancorp activist battle

I could write a novel about SFB Bancorp.  It would include all the usual characters, the entrenched bank management that's missing in action, the activist shareholder, and the legions of silent shareholders hoping for a satisfactory return.  The story has become VERY interesting, mostly because a group of value investors have taken it upon themselves to unlock value at a cheap company.

I wrote about the company in December and linked to my initial Oddball Stocks Newsletter writeup and also included an interview with the managing director at Trondheim Capital.  You can read that here.

For those of you with a tight time budget let me summarize.  This could be the story of most small community banks.

A long time ago in a rural area no one has heard of a group of people started a bank.  The bank operated mostly untouched for decades.  At some point shares began to trade, either from an IPO or a mutual conversion.  The bank likes to proclaim their record of profitability, although it's worth noting they don't differentiate between merely profitable and earning a satisfactory return.  That's probably because management has no idea what "satisfactory return" or "cost of capital" means, to them earning $1 more than $0 is considered success.

SFB Bancorp IPO'ed in the late 1990s and shares traded at almost the exact same price for the next 13 years.  The only return anyone earned besides interest was the free toasters (I'm presuming, it's that caliber of bank) given away to depositors for opening accounts.  Shares traded for ~30% of book value in 2013.  This was when Trondheim Capital discovered the bank and began the process of unlocking shareholder value.

There is a paradox at this bank, management repurchased 40% of their outstanding shares, yet they claim they don't understand how to correctly compute book value.  The company would deliberately compute book value per share based on the number of issued shares, not their outstanding shares.  And when a company re-purchases as much stock as they did a significant difference in the value is created.  The company was re-purchasing shares from shareholders and claiming shareholders got a good deal compared to "book value", the erroneously calculated value.  Does that sound like a bait and switch? It was.  And it speaks volumes to the quality of the people running the bank.

I spoke with a banker recently who made the comment that "most bankers are playing bank." Management at SFB Bancorp is clearly "playing bank."

Many community bankers like the idea of being a stalwart in the community, belonging to a country club, knowing business leaders by name and having status in a small town.  This is desirable, and it's understandable, and perfectly acceptable if the bank is private.  The CEO of SFB Bancorp is also an attorney and for all intensive purposes is 100% focused on his law practice verses the day to day operations of the bank, or even the long term bank strategy.  I tried to call him twice a little over a year ago, the first time he was unavailable due to his attorney obligations, and the second time he said he didn't have time to chat because he had a case he was preparing for.  Is this the type of person who should be running a public bank?  It's like he's moonlighting as a bank CEO.  If it's a slow week at the law practice maybe he'll think about banking a little bit.

I don't want to get into character details too much because anyone can sling mud.  And what I might find disagreeable might be acceptable to others.  But I think any and all shareholders can agree that management who cares more about their law practice rather than the bank shouldn't be employed by the bank any longer.  And management that doesn't care about shareholders earning a satisfactory return need to be replaced.  I don't know of any investment strategy where earning 0% over 13 years is considered successful.

The question you're probably wondering is "where do things stand right now?"  This is where the story gets interesting.  Trondheim Capital, Meixler Investment Management, and outside investors have amassed a position that is equal to or greater than management's own stake.  And Trondheim is pushing for two Board seats, a request that isn't unusual given their ownership position.  Suddenly bank management has been woken up from their very deep slumber, they hired an expensive DC law firm and have been stone-walling shareholders.  No one knows when the annual meeting is, what the record date for voting, and any further questions are met with sham responses.  I submitted my own proposal that the bank convert to an S-Corp, buy shareholders out at book ($40 per share) and pay out 90% of net income as dividends post conversion.  The company could do a conversion like this with cash on hand.  Their response to me was a copy and paste letter stating that I failed to meet certain bylaw requirements in how I worded my request.  This is the same transaction that North State Bank undertook last year.  I wrote about it for Seeking Alpha.

A friend of mine decided to pursue his shareholder proposal further than I did, I gave up after receiving my form letter.  My friend has found that each iteration has been met with more phony rules and requirements that are seemingly created on the fly.

Predictably the bank is sending letters to shareholders about the "out of town" activists and how they want to take over the bank.  The implication is these activists are from evil big city hedge funds looking to pillage this helpless bank.  There are two ironies with this branding.  The first is one of the funds, Meixler Investment Management, is located in rural Arizona and the fund principle is involved in an organic farm co-op project.  A rural investment fund that is working on a project to help farmers probably has more in common with SFB depositors than SFB management itself does.  The second irony is that management is willing to sell the bank and they don't need hedge funds to force a sale.  Rumors have floated around that SFB Bancorp shopped itself a few years back but the price they wanted was too high.  Management is willing to dump the bank, but only if they get to set the rules.

I've really only scratched the surface on SFB Bancorp, but if I've whetted your appetite there is a lot more reading available.  Trondheim in a very rare and unusual move has published ALL of their correspondence with the bank and bank management.  They've also provided a number of other resources on the website http://sfbkshareholders.com .  The website is a case study on small company activism.  If you've ever thought of attempting this yourself Trondheim has paved the way by making all of this information public and free.

If you are a shareholder I'd ask that you vote for Trondheim and Meixler Investment Management on your proxy.

Disclosure: Long SFBK

Why "dead money" stocks can still be valuable

There's an expression in real estate investing that you "make money when you buy."  The expression means a real estate investor makes money not on growing rents, outsized appreciation, or through cosmetic improvements, but rather by buying a property at a large discount to what comps are selling for (real estate's intrinsic value).  Often a purchase discount is obtained because some material deficiency needs to be remediated and other buyers aren't interested in tackling the project.  Other times the buyer has a vision and means to implement it for a project that other buyers don't.

A real estate investor can make money from appreciation, or growing rents, but the surest way to ensure an adequate return on investment is to pay less at the purchase.  The same principle applies for investors who buy extremely illiquid stocks, or stocks that the market considers "dead money."  These are the stocks that are covered in dust bunnies and haven't seen daylight since the Nixon administration.

Investors have very little patience.  CNBC's entire premise is that you're missing out on something this exact second if you're not watching them.  The WSJ makes money on daily news. Financial websites on the internet are biased to what's happening right now.  This urgency has predictably trickled down investors.  Funds like to talk about how they look for investments with a catalyst, some event that will unlock value quickly.  They need a catalyst because their investors, the ones watching CNBC and reading the WSJ don't have patience anymore to see an idea develop and won't tolerate their managers waiting a few quarters, or gasp, a year or more for a thesis to play out.  This obsession with catalysts has made its way to individual investors as well.  Not many investors have much patience anymore.

This lack of patience becomes a problem with deep value investing because there are some stocks that require extreme patience.  I'm not talking about holding stocks a few months or even a year before value is realized, instead these are companies that might need to be held a decade, or even two decades before an eventual liquidity event or sale near intrinsic value.  Holding a stock this long required extreme conviction, extreme patience, or willful neglect.

Value investors fishing in the deepest ends of the value pool need to be like real estate investors who lock in their gains when they purchase.  Buying at an extremely steep discounts is warranted for these types of stocks.

Because some of this is such a foreign concept to most investors let's look at an example of one of my favorite dead stocks; a stock that has lost all investor interest, Hanover Foods (HNFSA, HNFSB).  The A shares trade for $82, the same price they were trading for in 2003.  The stock has seesawed in the intervening years climbing as high as $120, and then subsequently falling back to the $80 level multiple times.  What's interesting is that while the share price is unchanged from 13 years ago the business has continued to grow.

I put together a small table comparing a few aspects from 2003 and 2016:

The company has also paid $14.30 in dividends since 2003.  A shareholder holding for the past 13 years would have a 17% cumulative gain, entirely from dividends.  Yet the discount gap has grown from shares trading at 66% of book value in 2003 to shares trading for 27% of book value today.  

Let's look at this from the perspective of a 2003 buyer.  They've made a measly 17% return over 13 years, or 1.3% per year.  Yet the company's book value has grown at 7% a year over the past 13 years.

Now imagine that the market continues to ignore the company for another 10 years as the company continues to grow as it has for the past 13 years.  If the company continued to trade for about 30% of book value and an investor sold in 10 years they'd have a roughly 11% annualized return over that period.  This is due to the discount price at purchase plus the growth of the company's book value.  The math for this is compelling, I've built out a table of potential sale prices based on P/B multiples factoring in the company's growth rate as well as the holding period.  The rate of return calculation is a simple cumulative return divided by the holding period.  This table presumes an investor holds the shares the entire time and doesn't add or sell anything.


At worst the company continues to trade at their current discount and an investor sells in five or 10 years and makes 10% annualized plus a percent or so in dividends.  But maybe one day the market might realize there is value in Hanover Foods and the shares potentially trade at 50% or even 75% of book value.  If an investor were to buy today and sell their shares at 75% of book value in 20 years they'd be looking at a 47% annualized rate or return on their investment.  These are numbers that fortunes are made of.  But only fortunes for those patient (or stupid) enough to hold a dead money stock for decades. 

The issue is very few investors have the patience to sit idly and watch a stock do nothing.  Even fewer investors can do this with a stock that isn't SEC filing, is hard to purchase and the market has left for dead.  But those few investors who have an iron constitution can stand to make sizable returns.  A return for doing nothing, just buying into something with a little growth at an eye-poppingly low valuation.

The largest risk for an investor in a dead money situation is if the valuation gap widens.  This is what happened to Hanover over the past 13 years, they traded down from 66% of book value in 2003 to 27% of book value currently.  If in 10 more years the company still trades for $82 they'll be trading for 14% of book value.

At some point the discount becomes too large and value becomes its own catalyst.  Clearly 27% of book value isn't cheap enough  Maybe 14% of book value will be?  Maybe 7% of book value will be?  I don't know, but at some point the market quote for a growing profitable company simply becomes too great and investors start to take notice.  Of course most investors will find a million reasons to avoid the company.  And most are valid, and they'd be very valid at 80% or 100% of book value.  But can some of those issues be overlooked at 27% of book value?  Apparently not.  Maybe at 15% they'll be overlooked, or maybe at 7%.

If it seems like there are no investors left interested in Hanover it's because that's true.  Almost every long time shareholder I have spoken to has thrown in the towel and moved on.  At this point I'm not sure who owns shares anymore, but as shareholders give up the discount widens.  

Stocks like this aren't for everyone.  There is no catalyst in sight.  Interested investors don't need to act soon, you'll probably be able to pick up shares for $80 next year, and in three years and probably again in five years, there's no rush at all.  My kids will probably grow up and graduate college before I ever see a return with this stock.  But if shares ever do trade up to 50% of book value or even 75% of book value over that time I could end up with an excellent return, and I'm willing to sit on my hands until that happens.

Hanover is a simple example of this principle, but there are a number of companies that are like this.  Shares trade for significant discounts to ultimate realizable value, but gains will only be realized by those willing to wait what's considered an eternity in our fast driven market.

Disclosure: Long Hanover

Announcing the Microcap Conference Toronto Lineup

The Microcap Conference in Toronto is quickly approaching.  If you haven't registered yet please do so now.

Canada is ripe with investment opportunity, and we've found some of the best micro cap companies in Canada.  Each company will give an investor presentation, they will also have management available for one on one sessions where you get unfiltered access to management.

Presenting Companies:

Ackroo, Apivio Systems, Avante Logixx, BioSyent, Biotricity, BrightPath Early Learning, Cematrix Corporation, DataWind, DealNet Capital Corp., Empire Industries, Feronia, FLYHT Aerospace Solutions, Hamilton Thorne, iAnthus, IPlayco, Kraken Sonar, LED Medical Diagnostics, Lingo Media Corporation, Medicure, Memex, Moseda Technologies, Nuvo Pharmaceuticals, Pioneering Technology, ProMIS Neurosciences, Quest Solution, Questor Technology, Renoworks Software, Snipp Interactive, Symbility Solutions, Urbanimmersive, Terastream Broadband, and XPEL Technologies. Plus 5 more names coming soon!

Speakers:

The conference has quite the line-up of presenting companies, but we also have an incredible set of speakers.  These are not speakers with glossy resumes with the purpose of filling a room.  Rather these are speakers who have practical investing experience and are excited to share their ideas with you.

Canadian Micro-Cap Stock Out-performance - Stephen Foerster -Ivey Business School
The Discovery Process - Paul Andreola & Brandon Mackie - SmallCap Discoveries
Event Driven Value Investing - Chris DeMuth & Andrew Walker - Rangeley Capital / Sifting The World
Emerging Technology - Sean Peasgood - Sophic Capital
Market dynamics - Benj Gallander - Contra The Heard
Small-cap growth at a reasonable price - Maj Soueidan - GeoInvesting
Deep Value - David Waters - Alluvial Capital /OTC Adventures
Small bank investing - Nate Tobik - Oddball Stocks / CompleteBankData


The Bank Investor's Handbook Free Chapter: Are Banks Risky?

Three years ago to the month I wrote my most popular post "A Banking Primer" laying out the basics of banking and bank investment.  The post started with the following statement: "There are two types of value investors, those who invest in banks, and those who don't."

In the ensuing three years I've received numerous emails asking for details on how banks work and how to analyze and value them.  I've been asked for book references when people want to learn more.  The problem is there aren't any great books for investors who aren't neck deep in the banking world.  I have a stack of bank investing books on my bookshelf.  Most could be used a ballast for a ship in a pinch.  The text is just as dense as the physical object.  These are books not meant for mere mortals to read.

A good friend and I started to toss the idea back and forth of writing a new type of bank investing book.  A book aimed at investors who are interested in learning, but not interested in being flooded with details.  This book isn't for bank experts, you already know this material and could write a similar book.  The book is for anyone who is interested in learning more about banking, what makes it unique, why banks are attractive investments, and how to look at bank stocks.  There are no discussions of how to hedge interest rate risk with Treasury options.  And no discussions on how to value mortgage backed securities.

Think of this book as a startup guide to banking.  We want to provide enough information to get you interested and looking at banks.  But we are not writing a sleeping aid either.

The book is underway and we hope to have it released in the next few months.  In the meantime in exchange for your email address to keep you posted on the book we're giving away a sample chapter, Are Banks Risky.  A note of fair warning, this is not the final edit of this chapter, what is included in the book could be different based on your feedback and comments.

Signing up below you'll receive a free chapter and we'll keep you up to date on developments in the book.  I intend to send a few short emails to the list with our progress, and list subscribers will be the first to know when the book is released.  Subscribers might also be privy to discounts and deals, who knows, why not sign up and see?

Sign-up and receive the chapter "Are Banks Risky?" from the upcoming Oddball Stocks Bank Investor's Handbook

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George Risk - a potential double hiding at NCAV

This write-up appeared in the latest issue of the Oddball Stocks Newsletter.  The newsletter is the premium version of this blog.  The newsletter is published six times a year and is loaded with oddball stock write-ups that are exclusive for subscribers.  Each issue highlights multiple oddball stocks, bank equities and includes a post by a guest writer.  Subscribers also have access to a subscriber-only forum where we discuss ideas related to the newsletter.

If you're interested in finding investments far off the beaten path where the market isn't efficient you need to subscribe to the Oddball Stocks Newsletter.  The cost is $590/yr.  Subscribe here.

George Risk Industries Inc. (RSKIA) – The recent turmoil in the markets has hit small cap stocks harder than the broader market and George Risk is no exception.  The company is located in Kimball, NE and manufactures a wide range of sensors and switches.

The company owns two small manufacturing plants located smack dab in the middle of Nebraska.  Both plants are relatively modest facilities in very small towns.

George Risk, the grandfather of the current CEO, Stephanie Risk, founded the company in 1965.  Prior to Stephanie taking control her father, Ken Risk, was CEO.  All three have managed to grow and expand the company.

I remember buying the stock around six years ago in the $4 range.  The memory is clear because I was working on building a position in the days right before and after our first son was born.  It took a number of days to build a full position, but it was possible.  Shares continued to rise with the company’s earnings and I sold out at over $7 a share in 2012.  It was a stereotypical oddball investment.  At the time of the initial investment the company was selling for less than their net cash and securities, was profitable and growing.  All I needed to do was buy and wait.

In the six years since I invested in the company I’ve loosely followed their quarterly reports and price.  The price reached a high of $9.04 in 2014 but since then has fallen to $6.55 as the company itself has continued to grow.  When I purchased shares in 2010 revenue was $7.8m a year.  In 2015 the company earned $11.9m, a growth rate of 8.8% a year.  This isn’t a high-flying growth stock, but 8.8% revenue growth is knocking the cover off the ball for a company that not only traded below its net current asset value (NCAV), but net cash and securities.  Their revenue growth has been great, but earnings growth has been even higher at 17.8% a year over the past six years.  Earnings per share have doubled from $.26 in 2010 to $.59 in the TTM.

And yet, with this sort of underlying growth the stock price has remained stagnant since 2012.  The company is once again trading right at NCAV, which is $32.44m, while their market cap $32.9m.  So what’s the problem?

The company’s problem is that they are successful in a small niche, but have almost no reinvestment opportunities.  The company has a 57% gross margin and a 20% net margin, enviable margins for any business.  Yet, there are few if any outlets for their excess cash.  They own simple facilities and their intellectual property walks out the door each evening.  The company dominates its niche, but is also stuck in that same niche.

In turn, the majority of their NCAV is stuck in cash and an equity portfolio.  Both cash and securities have continued to grow over time.  When I initially researched the company I thought the cash pile was a tax-efficient way for Ken Risk to grow a retirement portfolio.  He could build up a sizable kitty inside the company and then live off the dividends in his golden years.  If that was Ken Risk’s dream, however, it went unfulfilled as he died suddenly in 2013 and sadly didn’t get to see his golden years.  His daughter Stephanie, the former CFO, took over as CEO in his absence.

If you would have asked me in 2010 if I thought the event of Ken Risk’s passing would unlock value I would have said yes.  Unfortunately, it hasn’t.  The underlying company continues to operate as it has, but nothing else has changed, especially the share price.

Shareholders are right to be worried about the cash and investment portfolio.  It’s money the company controls, not shareholders.  A nice change is that the company paid out more than 100% of their net income as a dividend in the first six months of 2015.  During that time they earned $1.2m and paid out $1.7m in dividends.  If they continue this they will slowly liquidate and pay out their excess cash and securities holdings, but who knows if that will occur.

The eternal question is whether the company is worth more than their current price.  I can understand why the market is pricing the company the way it is.  While the operations are great they are small and stuck in a niche that they appear to be unable (or perhaps unwilling) to grow out of.  The company is also saddled with all that excess cash and the investment portfolio and the Risk family owns a majority stake in the company.

If management was serious about having the value of their business recognized by the market they’d pay out a dividend equal to 75% of their market cap.  Subsequent to such a dividend shares would be trading at approximately $1.50, and a company with 17% earnings growth and $.59 per share in earnings wouldn’t trade at $1.50 for long.  In such a scenario it wouldn’t surprise me to see shares rise to $7 or more, especially if earnings and revenue continue to grow.  The only thing stopping this scenario is entrenched management that seems content with business as usual.  

Is screening completely worthless?

Screening for investment ideas is universally derided.  Value investors hate it, growth investors hate it, it seems everyone hates screening.  We're told screens never turn up good ideas, and screens are a one way ticket to value trap heaven, or a million other things.

The unanimous view that screens are worthless has led to a predictable result, almost no investors screens for stocks anymore.  In the past few years I haven't spoken to anyone who proudly admits to screening, myself excluded.  A few investors will mention in passing they use it as part of their strategy, but the importance is downplayed.

I believe that screening is just another tool in an investors toolbox.  Each tool has a role, and if we try to use a tool incorrectly we'll end up frustrated or with incorrect results.  A drill is great to bore holes, or twist a screw, but I've never tried to use the butt of my drill to hammer in a nail.  Yet that's exactly what investors try to do with screens, and inevitably they come up frustrated.

Imagine I gave you a giant bucket full of a variety of coins.  I told you "find me the most valuable coins in the bucket."  How would you proceed?  Because the bucket is big, and no one has endless time you'd probably try to create a search strategy.  The first step might be to divide the coins into respective groupings based on denomination.  Quarters in one pile, pennies in another.  From there you'd want to focus your efforts on the pile with the most potential.  If pennies from before 1920 are valuable you'd probably disregard the nickels and quarters and start looking at each penny.  But even within the pennies you wouldn't look at every one, you'd just scan the dates for anything before 1920 and put those into a pile.

If you found pennies minted before 1920 then you'd probably search through that much smaller pile for the ones in the best condition.  But what if you didn't find any pennies from before 1920?  Maybe you'd start to look through the dime or nickel pile.  This process would be repeated until you found the most valuable coins in the bucket.

Screening for stocks is the same as searching for valuable coins in a bucket.  The problem is people expect it to be something different.  They expect a stock screener to be like a magical tool that will sift through all the coins in the bucket and find the most valuable ones automatically.  

At the most basic level a screener is a tool that's used to limit the universe of stocks that an investor needs to search.  It doesn't eliminate searching or analysis, but it helps reduce the work load.

In our society there's a macho factor to doing tasks by yourself.  I get this, I'm a DIY-er, but it's not for the macho factor, but because I like to save money.  For many though it's a source of pride.  "You bought your Christmas Tree at a nursery? Ha. I walked through the snow in the woods to cut it down myself!"

There is a benefit to knowing how to do something yourself.  There's a cost savings usually associated with it as well.  But there's also a time component.  While it might be cool to rebuild an engine in the garage it also takes a lot of time.  If engine repair is a hobby and it's enjoyable then it's probably a good use of time.  But it doesn't make sense in most cases for a highly paid professional to take off a week and try to learn how to rebuild their engine when someone else can do it for them allowing them to focus on their work.

Investing like most things in life is about results.  We congratulate our kids for how hard they worked on the field, or how hard they worked in class, but if they're working hard and failing something is broken. Likewise hard work can lead to good performance, but it's no guarantee.  If a company is cheap the stock doesn't reward the investor who read every 10-K for the last 30 years any more than the guy who coat-tailed and purchased given they buy at the same price.  That's what's great about investing, but also frustrating.  One investor can put in loads of work, while another barely scans the financials on Bloomberg and if both invest at the same price and the stock rises 50% both investors gain 50% regardless of the work effort before committing capital.

Outside of investing screening/filtering/searching is hailed as a great innovation.  Instead of having to leaf through volumes of the encyclopedia one can type a few words into Google and in seconds find the answer they were looking for.  The amount of data and availability of it is greater now than it's ever been.  And ironically investors are now ignoring tools that help them sort through this data easier preferring a tedious manual approach.

There are a few man criticisms of screening that I want to address.

Garbage in garbage out

The biggest weakness of a screen is the underlying data.  If the underlying data is crummy then any tool built on top of it will be equally crummy.  This is intuitive.  How could a tool with underlying bad data produce good results?

The challenge is when investors want to run a screen across an investment opportunity set where little good data exists.  In this case the best research is picking up the phone and calling anyone who will talk.  I'd say this sort of scenario exists in maybe 1-3% of all investment situations, and if you find yourself in that situation a screen is not the right tool for the job.

Before running a screen make sure the data source used for the screening tool is sound.

Screens are historical not forward looking

A lot of investors are out searching for investments at inflection points, or for investments with catalysts that will catapult shares to the moon.  If you're looking for stocks where something abnormal needs to happen for value to be realized or created then no tool will be of use.  Investors in these situations rely on past patterns and gut feelings.  Will Sears retail turn around?  Past results indicate it's unlikely, but Lampert and Berkowitz have stuck their fingers in the wind and decided otherwise.

Thankfully for most traded companies the future will resemble the past.  A bad management team that has destroyed value will most likely continue to destroy value going forward.  Likewise a good management team that has grown a company will likely continue to grow it in the future.  The future is uncertain but in the business world no one likes change.  Changing suppliers is difficult, changing processes is difficult, changing a business is difficult.  Most business is biased towards sameness.  

Screens uncover bad investments

When a tool is used incorrectly it shouldn't be surprising if the results are incorrect.  The purpose of a screener is to limit the universe of potential investment opportunities one needs to research.  It's not to find a good investment.  The more strict a screen the more likely it will turn up garbage.

I have tried to craft extremely complicated screens in the past and the result is always the same.  I'll end up with three companies that match, and none of those three companies are worth investing in.  

What screeners are good for

Screeners work very well when one is looking to narrow down the investable universe.  For example, if I know I want companies with revenue why would I waste my time evaluating zero revenue companies? Rather it'd be easier to run a screen and ask for all companies with revenue greater than zero.  Is it possible I'll miss some company that the market thinks has no revenue but really does?  Sure it's possible, but I recognize and have accepted the fact that I will miss thousands of good investments because I don't have time to track 66,000 stocks worldwide.

I've had a lot of success pulling lists of stocks with broad criteria such as "stocks trading for less than book value." Or "stocks with insider ownership that are profitable."  These are not complicated screens, but they reduce my time weeding through companies I'd never consider investing in in the first place.

Screens are also paradoxically good at finding a very specific match.  When I built CompleteBankData one of my goals was to provide a search mechanism that would allow a user to search over 1,700 pieces of industry specific bank metrics.  While investors scoff at the ability to find something quickly non-investors cherish this functionality.  Bankers can find direct competitors in a few minutes, users can find potential clients that match their ideal customer profile, and researchers can find institutions that have certain characteristics.  The ability to search through an enormous pile of data and find an exact match is eye-opening.  Our users no longer have to open the metaphorical encyclopedia, they now have something similar to Google.

My parting thoughts on screening are varied.  I'd encourage investors to look at screens because no one else is anymore.  If you are looking for bargains it's helpful to look where no one else is.  Everyone is looking at VIC, Seeking Alpha, SumZero, hedge fund holdings and message boards.  But no one is screening to source original ideas.  There is value in going where the crowd isn't.

On another level some people like to work for the sake of working.  Maybe you like to read annual reports in companies you'll never invest in.  Or maybe you just like to analyze companies to pass the time.  Or maybe you have a boss that requires it.  In these cases screening doesn't make sense.  It's like the person who spends an entire Saturday and $50 changing their oil when it could have been done in 15 minutes for $20.  If you enjoy the process then why not?

For myself I want the results, and I want shortcuts.  I'm busy enough as it is, and if investing didn't have shortcuts then I'm not sure how I'd have time for other activities.  I'm a firm believer in the "work smarter not work harder" school of thought.  I've built my business and my life around this.  That with intelligence and proper tools I can get more and better things done.  I believe that screening to reduce the universe of potential investments makes sense for me.  If you're interested in reducing your workload, or spending more time analyzing rather than searching then I'd consider looking at screens again.

For the naysayers I'll leave with this last thought.  I've had a 3-bagger and a 10-bagger both discovered with screens.  They've had value for me at least, and I'm content to be digging where others aren't, especially with a power tools when the masses prefer to dig with their hands.