Is it time to dump George Risk?

George Risk, a favorite of value bloggers, and value investors.  The company's investment thesis was so simple to understand, yet they seemed to sidestep all of the attributes that a net-net would normally have.

George Risk is a small company based in Kimball Nebraska that manufactures safety switches for pools, electronics components and outdated computer peripherals.  They have two locations, and are run by the Risk family.  Their CEO, Ken Risk passed away recently, which meant that his daughter, Stephanie Risk the CFO was promoted to CEO.

When I purchased the company in early 2010 they were selling for less than NCAV, and most of NCAV was comprised of cash and a securities portfolio.  The business itself was profitable, earning $.10 p/s in 2009, and $.30 p/s in 2010.  An investor could buy the cash and securities at a discount and get a profitable business for free.

As the economy has recovered from the recession the company's sales have grown considerably, they earned $.52 p/s in 2012 and $.40 p/s in 2011.  Earnings have grown 73% since 2010.  The company's portfolio of mutual funds has grown with the market increasing their NCAV roughly in line with the market.

If there ever was a stock to sell investors on a style of deep value investing, George Risk was it.  They had the safety and simplicity of being available for purchase below net cash and securities, and they had a profitable and growing business attached.  George Risk was really the perfect child of net-net investments, at least on the surface.

I know a number of bloggers and investors made a stink about Ken Risk, the 60% owner of the company expensing $14k worth of airplane incidentals and lease payments a year.  That never bothered me, what bothered me was their product catalog.  Outside of their pool safety switches the company sells higher priced electronics components, and computer peripherals that are outdated.  The company mentions the keyboards they manufacture ten times in their annual report.  Let's just say it would be very hard to buy a computer old enough that would allow the keyboard to work without a frankenstein mess of adapters.

Beyond the products, I worried about leadership and personnel.  It's hard to find good talent in a medium sized city, let alone in a small town (Kimball pop 2500) in the middle of Nebraska.  It would be very hard for the company to attract talent, and while I'm sure there are some very talented individuals who already reside in Kimball, the talent pool is small.  Based on Wikipedia pictures Kimball has a classic American small town look.

Even with the worries the stock was undeniably cheap a few years ago.  It's since risen 87% since my purchase, and it's now trading close to $10, which is the value I had mentally pegged as "fair value", which is a signal that I needed to look into the company again.

I feel that selling stocks is a weakness for most investors, if not all investors.  It's easy to spot a bargain and buy it, but it's hard to tell when the music is over and it's time to sell.  In general I try to keep a few things in mind when I look to sell a stock.  The first is whether the company has a margin of safety at the current level.  For most investments this means an asset backed margin of safety.  I do own one moat stock, Mastercard, and the margin of safety for that stock is the brand.  If there is still a margin of safety at the current price, and nothing else has changed with the business I will continue to hold.

The best investments are ones where the company's NCAV grows with the stock price, and a year or two after purchasing an investor owns an appreciated stock with the same safety they held when they first purchased.  That's unfortunately rare, although it appeared true for George Risk.

Beyond looking for a margin of safety I look to see if anything has changed in the business.  If a business that was once strong is now stumbling, and the stock is getting pricy it's time to sell.  There might be gains left, but why try to sell at the top, it's a fools errand.

If a margin of safety still exists, and it's business as usual I do nothing.  Doing nothing is the most underrated investment activity.  Most often the best investment decision is no decision.

Back to George Risk, a second issue came to light that caused me to re-evaluate the company's role in my portfolio.  The company filed a 10-K NT recently, the 10-K should be out soon, but this is a potential warning flag.  The company hasn't filed a NT since 2009, this one comes on the back of Stephanie Risk's father passing.  A narrative could be constructed that Risk has her plate full both running the company and trying to manage the financials and the company missed filing their annual report.  I have no idea if this is true, but that was my first thought when I saw the 10-K NT filing.

Along with the 10-K NT filing I'm starting to feel uncomfortable with the company's current valuation.
The company has a book value of approximately $30m, and they are on track to have about $2m in FCF during 2013.  Their cash and securities are worth $26m, so the company has a EV/FCF of 9.5.  The company isn't cheap on an asset basis anymore, and for a small family controlled micro-cap they're heading into richly valued territory for their earnings as well.

I'm going to do nothing with the position until after the 10-K is out.  My guess is the company earns $.50 a share, or similar again, and book value will have grown slightly.  I'm also going to continue thinking about selling the position.  I love this at $6, but at $9 not as much.  I'm sure there are some readers out there who have a bull case for the company, if so I'd love to read it, toss it in the comments.

Disclosure: Long George Risk