...was PC Connection back in September 2010 when it was trading at $6.85 a share.
The thesis was pretty simple. There was $6.70 per share in working capital (current assets - all liabilities).
Assuming a 10x multiple for the business at a $0.45 earnings level for the year would have valued the business at $4.50, so that ($4.50+$6.70) suggested a valuation of $11.20. Or, being more conservative and placing a 10x multiple on the then-current earnings (and assuming no growth for the year) resulted in a $2.70 value for the business and thus $9.40 for everything. So, back then the "conservative" estimate was a 40% upside from the trading price.
So what happened along the way? Well, note that in 2016, the company changed its name to "Connection" and the ticker symbol to CNXN. Names are trendy and subject to fads, so one thing that we find is that doing a retrospective can be more complicated than just typing in the ticker symbol.
But here is the stunner: the share price is now $36!
Starting in November 2011, the company paid a dividend of $0.40 and then has paid an annual end of year dividend of similar amounts since then, for a total of $2.98 of dividends. The dividends plus the share price appreciation have resulted in an IRR of 24% compounded for eight and a half years!
Let's look at what happened here. Revenue grew from $1.9 billion for the year ending at the time of the blog post to $2.7 billion for the year 2018. Gross margin grew from 11.6% to 15.2%. The result is that gross profit almost doubled (+88%). Meanwhile, SG&A only grew 70%, so operating income more than doubled.
The result is that earnings per share have grown and in 2018 they were $2.41 a share. (They were 85 cents a share for the full year of 2010.)
So, coming out of the recession you could buy this business for 15 cents a share because current assets covered almost the entire purchase price - and it ended up being a growth stock that had nice operating leverage.
We've been talking about this lately... price rules. Whenever a business sells for a really low price (e.g. for no price once you subtract current assets minus all liabilities, or for zero or negative enterprise value), the market is already acknowledging the problems people are worried about: a recession, a business that seems to be highly competitive and lacking a moat; or in other cases, bad management, bad capital allocation, unfriendly insiders.
Sometimes bad factors win out and a company goes to zero. Or a stock purchase can do really poorly even if they company survives when too high a price is paid. But when companies don't have much debt (and that's what a low or negative enterprise value is telling you), there is a lot more runway to try to improve things. So much more runway, in fact, that most shortsellers are not very interested in situations where there are not financial debts or other fixed liabilities to act as catalysts.
How do you think about the valuation based off earnings plus the working capital? Isn't there some degree of double-counting because the working capital is required to generate the income in the first place or is the thought more that the company will generate earnings for a number of years and a conservative terminal value is liquidating at NCAV? Thanks!