Hershey Creamery, a multibagger or mediocre?

Hershey Creamery (HRCY.PK)

Price: $1750 (4/3/2012) - Note doesn't trade often beware!!

I want to thank a reader who's an avid pink sheet investor for sending me some information on this stock along with a few others.  The information sent was invaluable.

Hershey Creamery is a ice cream manufacturer and distributer located in Harrisburg Pennsylvania.  They've been in business since 1894 and were started by the Hershey brothers.  Hershey Creamery is a completely separate company and has no relation to Hershey the candy company located in Hershey PA which is just down the road from Harrisburg.

Hershey Creamery manufacturers both ice cream, ice cream novelties, smoothies, and ice cream coffee drinks.  The company has an interesting distribution arrangement, they don't distribute to common grocery stores but rather distribute to stores where they can be the dominant ice cream product.  This means if you're at a Giant Eagle you won't find Hershey Ice Cream, but if you're at MacBeth's Gift Shop in Cooksburg PA you'll find the freezer stocked full (I speak from experience regarding MacBeths).

I've had Hershey Ice Cream in the past, but wanted to try it again before doing this post.  Unfortunately the place that sells it near my house has either closed for good or hasn't opened for the season yet.  We ended up getting some ice cream at a local place down the road which was awesome, but is a moot point in researching for this post.

The company has been run by the Holder family since the 1920s.  George Hughes Holder was the President and Chairman until he passed away in 2009.  The company is now run by his three sons.

Why is the company interesting?

Hershey Creamery is a typical unlisted company, they run like a private company but have shares that seem to trade on an ad-hoc basis.  The last time Hershey Creamery shares traded was January 23rd, when six shares traded hands.  The company has 96,066 shares outstanding but most reside as treasury stock, there are only 35,359 outstanding, and the majority of those are held by the Holder family.

Here are a few interesting items regarding the company:

• Hershey Ice Cream is sold in 28 states.
• The company operates 22 distribution centers.
• They're still headquartered in the same place as where they started in the 1800s.
• In 2010 they had $94m in sales, $4m in operating income and $3.7m in net income.
• EPS of $105.92 and a dividend of $16.80/sh
• The company has a $61.8m market cap
• Enterprise value of $15m if you include their portfolio of marketable securities (stocks, and cash)
• EV/EBIT of 3.77
• EV/FCF of 11.8
• ROE 4.12%
• ROE ex-cash of 8.48%

Here is the net-net worksheet:

What's it worth?


Hershey Creamery isn't a stellar business but they're pretty steady.  If you take into account the overcapitalization they're probably close to fairly valued currently.  On a cash plus operating business basis I can see maybe $2000 being a fair value, and $1750 isn't that far off, especially in the pink sheet world. 

Some people might argue that the company should trade at book value which would mean the company would be worth around $2565 a share.

The reality though is Hershey will probably trade where it's at unless either earnings explode (unlikely especially with high fuel costs) or if the company is bought out.  A buyout is the most likely way any value is going to be realized for a shareholder of Hershey Creamery.

I was able to get some stats on ice cream company buyouts over the years from Adam at ValueUncovered (big thanks!) and put together a spreadsheet showing what that might mean for Hershey Creamery.  I used price to sales because this was the most consistent ratio I could find in the dataset.

So going through the buyout data we get a range of possible values for Hershey going from $3706 a share to $10339 a share.  All significantly higher than what it trades at today, but all betting that the family that has run Hershey Creamery since 1920 decides to sell.

While there's significant upside for a shareholder if Hershey Creamery is sold I'm not optimistic that the company will actually be sold in the near future.  George Hughes Holder's sons seem intent on running the business the same way as their father did including keeping a large hoard of cash and paying out a paltry dividend.  If the company increased their payout, or something changed leading me to believe the sons were going to sell I would become very interested in Hershey Creamery, until then I'm content to watch them from the sidelines.

Talk to Nate about Hershey Creamery

Disclosure: No position

Conrad Industries...unanswered questions

I've seen this company mentioned on two excellent blogs here and here.  So as I read these posts the investment thesis seemed pretty clear, this is a currently cheap business, undeservedly cheap.  As I read the two posts I kept thinking of three questions that I didn't really see answered, they are as follows:

So why is it cheap?
Is it normally this cheap?
Is it as attractive as it first looked?

Conrad seems like a really interesting stock, something I'd usually be interested in, so I thought I'd take a stab at answering my own questions with the hope that I'd be looking at a good investment.

First a bit of background

Conrad Industries is in the business of building and repairing ocean going vessels as well as fabricating oil rigs and the related oil rig support vessels.  The company's website seems to promote their role in the oil and gas industry but reading through the press releases I kept seeing orders for barges more than anything else.  In 2011 of the 47 boats delivered 42 were barges, I think it's probably safe to say that Conrad is a barge manufacturer.  The demand for barges is closely tied to commodity prices across a few different industries, energy, agriculture and construction.  The barges I see mostly near me are carrying coal and gravel.

Conrad's barges aren't limited to one specific industry or client set, here is the list of barges and ships they built in 2011:

During 2011 we delivered 47 vessel construction jobs comprised of 2 crane barges, 2 ferries, 9 LPG barges, 2 tow boats, 9 deck barges, a spud barge, 9 30,000 bbl. tank barges, 2 10,000 tank barges, 5 hopper barges, 3 striker barges, a push boat and 2 docking barges.

The investment thesis is pretty simple:

• Market cap of $112.8m and an enterprise value of $70.8m
• EV/EBIT of 2.44
• EV/FCF of 2.832
• EV/CF3 of 4.56 (avg cash flow from the last three years)
• ROE of 20%
• ROE ex cash of 36%

The numbers are eye popping, I had to double check my math, how could a company like this be selling so cheaply?  

Why is it cheap?

I always want to know why a company is cheap before I buy it.  I know some investors think this is unnecessary but I want to make sure I'm not buying into a "cheap" company at the top of it's cycle right before sales drop off.  Or buying into something cheap that has a lawsuit hanging over it that could wipe it out.  Sometimes a company is cheap because there's a CEO who has said he'd rather spend the cash on acquisitions than give it back to shareholders (see Rimage..).  There are a lot of reasons, but for my own piece of mind I like to know before investing.

The writer CP at Credit Bubble Stocks mentions they think the stock is cheap because it's unlisted and has a market cap below $100m.  This is a fairly canned answer that I think is a red herring.  I can find literally hundreds of pink sheet stocks with market caps under $100m that are over valued, heck most have a share price of under $5 the other canned reason for undervaluation.  I guess I should throw in lack of analyst coverage as well here.  The reality is while those things might play a part I don't think they're a real reason a stock trades cheaply.  The addition of an analyst won't make Conrad pop 45% overnight unless that analyst is paid by Conrad and sends out glossy fliers...

John at Portfolio14 says in his post that the stock was punished with the BP spill last summer undeservedly so, this seems more plausible.  Of course the overhang from the spill is over so while this was probably a past reason for cheapness I don't think it's currently one.  Note that John picked up Conrad during the which was a much better investment than mine in Seahawk Drilling.

So moving on, my first thought after crunching the numbers was that Conrad is a cyclical company and that it's at the top of it's cycle. So I went back through their annual reports and pulled a few figures from the years, here's what I got

I think looking at revenue, margins, income and cash flow actually tells quite a story here.  Conrad Industries is anything but predictable.  A double digit jump in any value isn't unheard of, it's actually common.  Likewise a double digit drop is just as likely.

Revenue for 2011 came in at $246m, the highest ever and an increase of 28.8% over the previous highest amount from 2008.  Revenue and income are highly dependent on when construction of certain ships are completed and that varies by the type of ships ordered.  So in two different years ten ships could be ordered but in the first year eight of the ships completed and in the second year maybe only six completed leading to very lumpy results.

Is it normally this cheap?

I pulled up the longest chart I could get on Conrad Industries:

Clearly investors were very excited about Conrad's results back in 2008 when they hit an all time high similar to today.  The good news is the market price of Conrad seems to trade the company's performance.  To me this says if the future looks better than now then Conrad has room to grow.  If for some reason revenue drops, or net income drops look out below.

Is it still attractive?

This is really the most important question, and honestly the one I couldn't answer.  The company seems to be in a great position financially, they have a strong balance sheet and are internally financed.  The big question is how does the future look, will results in the future look similar to the past?

I think there are really two variables to answering this question in my mind at least, the first is the age, condition and demand for river barges, and secondly the future backlog.  At year end 2011 Conrad Industries had $144m in booked backlog if this is the only work they complete in 2012 revenue will take a significant hit in comparison to 2011.  Although this would be a big hit it won't be all that surprising taking a longer term view.  If the company is able to complete their backlog plus additional watercraft revenue will obviously be higher.  The question is can they sell and build their backlog twice?

I'd love to hear reader's opinions on Conrad Industries, bulls, bears please comment!  For me the jury is still out as to whether this is the sort of stock I want to add to my portfolio.

Talk to Nate about Conrad Industries

Disclosure: No position

Three Japanese net-net's compared

After my last post reviewing the book Investing in Japan I figured it was only appropriate to highlight a few Japanese companies.

I'm working my way through a list of Japanese net-net's again and I'm scoring them against a simple criteria:

• 10 years of positive EBIT
• 10 years of positive net income
• No debt
• Pays a dividend
• Shares decreasing or stable

I know this seems really strict, but believe it or not out of 100 or so companies that passed a strict net-net screen I'm getting companies that match the above criteria.  Because my approach to Japanese net-net's is mostly mechanical in nature I want the best possible companies I can find.  I'll leave the turnarounds and special situations for a Japanese equities specialist.  I just want to find cheap companies that should be mean reverting.

I am going to do this post a little different than most, I want to go over three profitable net-net's.  I will give a short business summary and background, and a look at the balance sheet through my net-net template.  I'm also going to use this post to roll out something new, a Japanese net-net comparison spreadsheet.  As I look at these companies I'm compiling some relevant metrics into a big spreadsheet so I can compare over a variety of data points.

I know it seems a bit ironic that after doing a post on how stocks are businesses I'm now posting financial details on three Japanese companies with a focus on financials and not the actual business.  The reality is when looking at net-net's in Japan I'm taking a bit of a quant approach.  I don't read/speak Japanese, I've never been there, I don't understand the culture, so the best I can do is make a judgement based on some numbers.  Without further ado:

Ryoyo Electric (8068, last trade ¥939)

Ryoyo Electric is a semiconductor company, seems like most cheap stocks are these days.  The company has three segments, integrated circuits, application specific circuits, and large scale integration circuits.  Ryoyo's products are a commodity and they end up being a price taker so they're subjected to the whims of the market.  The company is located in Tokyo.

Highlights

• Net cash company if you include long term investments, ¥950/sh
• Negative cash flow one of the last five years.
• Tokyo Exchange
• Debt free
• EV/EBITDA of 1.73
• NCAV of ¥2183
• NWCC of ¥1770

Choukeizai Sha (9476, last trade ¥340)

Choukeizai Sha is a book publishing company, they publish five magazine subscriptions and over 450 throughout the years.  The books mostly related to economics, management, law, accounting and tax related subjects.  I realize the publishing industry isn't the best right now but this company is trading at an absurd valuation.

Highlights

• The company has been profitable the last ten years.
• Positive cash flow and FCF for the past five years.
• ROE ex cash of 10%, the overcapitalization is penalizing the business.
• Osaka traded
• Debt free
• NCAV of ¥813
• NWCC of ¥677
• Net Cash ¥395, slightly above the last trade.

Shinko Shoji (8141, ¥715 last trade)

Shinko Shoji is a small cap exporter of electronic components, they import components from abroad, assemble them and then resell them internationally.  They sell memory chips, LCDs, semi-conductors, capacitors, and complete PC systems.

Highlights

• While posting a positive EBIT and positive net income for the past 10 years the cash tells a different story.  Cash flow is lumpy with big years ¥6b yen, and then years of ¥7b losses.
• Capex requirements appear to be very minimal.
• Tokyo listed (easier purchase for some investors)
• Sizable dividend yield above 4%.
• Paltry net margin
• NCAV ¥1395
• NWCC ¥806

Comparison Spreadsheet

Here are the three companies compared, I plan on adding to this spreadsheet as I research more Japanese net-net's.  I'm guessing of the original 100 companies I'll end up researching 10-15 and maybe purchasing 2-5, we'll see how it turns out.

Disclosure: Long 9476, and trying to acquire more shares.  

Investing In Japan

I don't usually do book reviews on this blog mainly because I rarely read a book that I think most readers would benefit from.  At times I've mentioned books that I think go well with a certain topic, but so far I haven't done a full scale book review.  This post is a first, and because I write about Japanese equities often this book will probably appeal to most readers.

Investing In Japan was written by Steven Towns a member of the proxy exchange and author of the blog Active Investing where he writes about shareholder activism and Japanese companies.  He has been a long time holder of Internet Initiative Japan and through shareholder proposals and discussions with management was able to get IIJ to increase their dividend 50%.  One aspect of this book that I really loved is that Steven Towns is a value investor himself and presents Japan through the eyes of a value investor.

For this review, I want to hit a few highlights from the book to give you a taste of what it contains.  I've seen reviews on Amazon where people give a summary of each chapter and my own take is if you want that much detail just go buy the book.

How to invest in Japan with ETFs and mutual funds

This was an interesting aspect of the book I didn't really expect, Steven dedicates two chapters to discuss different exchange traded vehicles for investing in Japan.  Towns uses ETFs to walk the reader through some basics on the Japanese market such as the different market sections, relevant indexes and index composition.

What I found really fascinating was the concentration of investments by the value funds represented in Japan.  Most of the value funds own the same set of large cap exporter stocks such as Toyota, Canon etc.  What's interesting about this is that the top holdings in most international value mutual funds are the same as the top holdings in Japanese index funds.  In most cases a value investor is better served either diving in and investing in individual equities on their own or buying a Japanese index fund for inexpensive exposure.  I would say that if someone wanted a lot of Japanese exposure an index fund to capture large/mega caps along with some individual small cap stocks is probably the best approach.  Of course I'm biased because this is what I do.

Macro/Bearish outlook

I would say the biggest thing holding back most investors from putting money into Japan is macro economic fears.  These fears stretch from worries about government debt, zero interest rate policy, low GDP,  a declining birth rate and a whole host of other worries.  Of course the worst time to invest is when it seems like there aren't any problems, or all the problems have been solved.  Given all the worry about Japan valuations are at twenty and thirty year lows with profitable companies selling for less than the net cash on their balance sheet.

I'm not going to go into a counter point for each bearish argument against Japan because Towns does a great job.  He discusses how fears of a Yen drop are mostly exaggerated, just a few years back companies were managing just fine at the ¥120-130 level, and are now managing alright at the ¥80 level.

The chapter also discusses Japan's supposed demographic time bomb and has a quote that I love:

"My point is for readers not to be misled to believe that Japan is so gray as to be on its last breath and in such dire straits that masses of unemployed youths pass time by occupying ubiquitous internet cafes."

He ends the chapter with the exhortation that any reader interested in Japan should at least make a visit.  Lost in the bearish investment speak is that Japan is an extremely modern country that's very safe to live and travel.  It seems every country right now has some sort of macro overhang even the US.  There is no place perfectly safe, investors just need to be mindful of the risks.

The one area I wish he would have covered here some some advice on hedging the Yen.  A fall in the Yen would be good for Japanese business, but I wonder if the increase in business value would offset forex losses.  I would rather hedge or partially hedge and get the best of both worlds.

Stock market essentials

There were two chapters covering everything from the history on minimum trading units to Japanese dividend policy.  There was a lot of information in these two chapters that I wish I had in one place before I started investing in Japanese companies.  I spent a lot of time Googling trying to figure out some of the peculiarities of the Japanese market.

The chapters on the market essentials also covers the often discussed cross shareholdings that many Japanese companies have.  One form of cross shareholding that's popular is listed subsidiaries.  I own a listed subsidiary and wondered what that reason was for the listing.  In Japan spinning off a company has some tax consequences that make it unattractive.  Instead of spinning off a subsidiary a parent company will simply list the sub.  There's some catalyst potential in parents taking listed subsidiaries private if the sub is very profitable and the parent wants control of the income stream.

Low ROE problem

It's not a secret that most Japanese companies have low ROE's compared to most other developed countries.  A lot of investors will get excited by the cheapness of Japanese companies and then see a ROE of 3.5% and end up walking away from the stock.  The book digs into the multitude of reasons that many Japanese companies have low ROEs.  The biggest is that most companies are overcapitalized both with cash and assets.  A second aspect is that many Japanese companies will invest in plant and productivity rather than trim the workforce because that's the easiest path forward.  This results in lower returns and inflated assets, assets that might be used eventually if Japan regains it's mojo.

Shareholder rights

The chapter on shareholder rights was tucked in the back, I think unfortunately because most investors don't care much about any rights they hold.  With that said this chapter is pure gold, Towns knows what he's talking about when it comes to shareholder activism and rights.  Interestingly enough an investor who owns more than $2000 of any Japanese stock has quite strong legal rights including the ability to call a board meeting.  The chapter lays out some specific rights all shareholders above the threshold have as well as going into some details on executive pay.

I wish there were more stories and concrete steps for an investor to take.  One takeaway I had was that Japanese companies aren't opposed to shareholder proposals but that most foreign investors propose incorrectly and ask for demands that are too large.  Investors who understand Japanese culture have had a lot of success in initiating change in corporate Japan.

Who should read the book?

I think any value investor who's curious about the persistent undervaluation of Japanese equities should do themselves a favor and read this book.  For someone who has been investing in Japan for years they might not have as much to gain from this book.  One thing that's worth mentioning is that Steven Towns sprinkles the book with lots of examples of undervalued companies and just the examples in the book alone are a great hunting ground for an aspiring Japanese stock picker.

Buy Investing in Japan: There is no stock market as undervalued and as misunderstood as Japan from Amazon.com

Disclosure: I purchased the book on my own.  If you order through the links above I will receive a small commission.  The price for the product is the same if you enter through my site or go to Amazon.com directly.

A net-net that's liquidating...how unusual

I want to thank Theodor Tonca a principal at Graham Theodor & Co for sending me this idea.  Graham Theodor & Co is a value based Canadian money manager.  For any value investors in Vancouver Theodor runs a value investing interest group, if you're in the area it's worth checking out their next meeting.

With most articles I do on net-net's I include my liquidation analysis spreadsheet.  I include this not because I think the company in question will liquidate, but to show the maximum possible downside.  In some cases the biggest downside (outside of fraud, or massive asset squandering) is actually an upside.  Of the net-net's I've written about and researched I don't think I remember any actually liquidating.

While I haven't had a net-net liquidate, although some should, I have been involved in one liquidation situation.  I purchased EDCI stock a few years back once the decision to liquidate was made and I realized the liquidation value was in excess of the trading price.  I ended up selling out way too early but I know people who held on made 2-3x or their initial investment, I ended up with a 50% gain in about four months or so which I thought was spectacular.  I blew the gains on a trip to Florida, and while stocks are nice they don't compare to a sunny sandy beach but I digress...

Maxco (MAXC)

So what's the deal with Maxco you ask?  Well management realized a few years back the best way they could realize maximum shareholder value was to liquidate the company and distribute the proceeds.  The company has liquidated substantially all of their assets at this point and made four distributions to date.

At this point all that's left of Maxco is the CEO, an empty office and the receptionist.  At the bottom of the annual report filed at the end of March 2011 management indicated they expect a final liquidating distribution of $.60.  The final distribution is a result of a large IRS refund they received last year.

The situation seems pretty straight forward, and you're probably wondering at this point if there are no assets left to liquidate why hasn't the company paid out the final distribution?  The reason is a bit unique, due to the size of the tax refund a special committee needs to review it before the company is allowed to release the funds to shareholders.  The IRS guidelines state that a review of this type can take up to 18 months depending on the complexity of the return.  The company mentioned they would update their website when the audit process began.  It's been a year since the last posting on Maxco's website so I decided to call and see if there were any updates, unfortunately there aren't.  The audit still hasn't started, although the woman I talked to said she doubts it will take the full 18 months given the simplicity of Maxco.

A shareholders return in this liquidation depends on two factors, the price they pay, and the amount of time between the purchase date and the liquidation date.  I've included a graphic I put together showing how the longer the process drags on, or the higher the price paid the return drops.  I know this is intuitive for most readers, but often a graphic makes it much easier to understand both the potential and liability.

Maxco looks like the perfect investment, put in a bid $.02 above the last quote, hope things wrap up in a year and you're looking at a 200% return.  I agree, this looks excellent on paper, the problem is it's very difficult to actually purchase shares, trust me I've been trying.

Here is a screenshot I grabbed of ALL the trades going back to September 2011:

Most trades are less than 1,000 shares ($180!?!?!) and my guess is they're partial fills.  If you decide you want Maxco shares I would strongly encourage a limit order with an all or nothing specification.

Why cheap?

No post would be complete without me asking this question, for Maxco this is very easy to answer:
-The current market cap is $621,730, yup, smallest stock I've ever written about.
-The stock is very illiquid as mentioned above.
-Uncertainty regarding the timing of the final distribution.

Talk to Nate about Maxco

Disclosure: I have an order outstanding for Maxco shares at $.18, yup I'm optimistic.

A stock is a business

This post might seem a bit off the farm, if you're looking for company writeups stop reading and check back later this week.  Otherwise let me step on a small soapbox for a minute or two.

Whopper put up a post recently on McRae Industries discussing the investment potential.  Whopper does a nice job laying out why someone would potentially want to invest based on financial metrics.  My quibble with the post has nothing to do with his reasoning or any accounting aspects but with this line

"McRae sells boots. We could go into a further breakdown of what they do, but there’s honestly no need. As you might expect of a company in the boot industry, McRae is pretty much a commodity company with commodity company like returns."

I think often value investors get stuck in a rut, they do a lot of research, reading company financial statements, reading about competitors (through financial statements), and reading about industry segments.  Left out of this process is the thought or connection that the business under the microscope is a collection of real people who gather in an office each day, talk about American Idol, gossip about each other, surf Facebook, all while taking customer calls and complaining about their boss.  As Avner Mandelman talks about in the The Sleuth Investor (highly recommended) a business is a place where people send checks.  He asks whether the customer being served is worthy (do they deserve to be served?), and how they're served (the business process), along with things like who is the customer, and who are the managers.  The Sleuth Investor really dives into looking at the physical aspect of a company, visiting the plant, talking to workers on their lunch break, and buying their product like a customer would and talking to customers if possible.

I know these things seem strange for most investors, especially value investors who model their behavior after Ben Graham who rarely talked to a company or Walter Schloss who almost never talked to companies.  Ultimately though I don't believe either of them had the detached mentality that has developed amongst a lot of value investors today.

The result of this detached mentality and focus only on financials is what sucked a lot of value investors into China RTO stocks.  On paper these companies looked like absolute steals.  Companies trading for less than cash, growth rates of 30-40% a year selling toasters.  Ultimately a lot of these companies were undone by investors who did the physical checks of these companies.  While vilified there is a lot to be said about Carson Block who counted trucks, talked to customers and sleuthed factories.  It wouldn't surprise me if Block has read the Sleuth Investor a few times.  The physical reality didn't jive with the financial statements and everything came undone.  The opposite could also be true for some companies, the physical could be much better than statements suggest offering a great opportunity for an investor.

The ideas in the Sleuth Investor resonated with me, probably because I work in the business world, deal with small and large companies daily and am mostly detached from the investment world (outside of this blog, twitter, and some emails).  My friends all work for various companies in non finance roles, to them investing is reserved for smart people in New York and London who wear suits to work everyday.  Investment to most people isn't P/B, ROE, or ROIC, it's buying a new machine to reduce lead time, streamlining distribution channels, or removing inefficiencies from a business process.  These are the tangible, physical things that drive a company's financial return.

For a while now I try to answer the question "Why is a company cheap?" when I research a business.  In looking at this question I was getting part way to answering some of the questions about the business itself, but not all the way there.

Why is this important?

Looking at a business as a physical group of people who collect checks for doing some sort of task opens the mind to think about a company differently.  My main goal in investing is to not lose money.  If I find a cheap stock and then look at pictures of it's facilities and realize they are decrepit and in disrepair I stand a chance of losing my investment.  I want the physical reality to confirm the financial reality of the company.

Other times thinking outside financial statements gives reasons as to why a stock might be cheap.  Consider a company located far from an airport, railroad or major urban area.  They might need to truck parts in, and truck out a finished product.  If gas prices rise they are impacted to a much greater extent then a company located in a major city, or near an airport with a short haul.  None of these things are mentioned in the 10-K, but are easy to find just looking on Google Maps.

A lot of people will dismiss this post saying that if a stock is cheap it doesn't matter what the business does, or how it does it.  I can agree at a point, for Japanese net-net's I have had trouble getting a solid grasp of what these businesses do, so I will invest on metrics.  This is fine, but I recognize that it's a somewhat mechanical strategy.  Even so, some basic Googeling can result in a lot of information, even about businesses overseas.

It seems crazy but even for a net-net I think examining the physical business is important, I looked at this with my post on Hickok. A small amount of time, such as 30-45 minutes of looking at maps, street view, and reading about an area online can give great insight to an investment.  Often this sort of in depth research seems to be reserved to people who concentrate hundreds of thousands or millions of dollars into a few investments.  I think it should be considered by all investors regardless of the investment size.  Relatively simple physical checks can yield really good results.

If feasible I think it's even worth trying to buy a product, or at least examining it.  Call the company and act like a client.  I tried this with AEY, they ignored me.  I tried to get quotes on a few pieces of equipment.  If they ignored me why would my experience be any different from any other potential client?

I think the level of research outside of financials probably scales with the size of an investment.  For someone putting $500 into a net-net a quick look on Google Maps and reading product reviews is fine.  For a $100,000 investment I'd expect the investor to at least have handled the product (if possible).  Think of it like this, for a few hundred dollars you could avoid a potential thousand dollar loss or more.

Putting it in Action

So I want to just consider a few questions about McRae in the vein of this post.


Where are the boots manufactured? - The army boots are manufactured in the US, the cowboy boots appear to be manufactured overseas.  This raises a whole other host of questions regarding leather availability in China (an issue facing Danier Leather).

Who buys these boots? - Identifying the customer is critical.  It appears there are probably four customers, soldiers, horse riders, industrial users, and possibly fashion buyers.

How easy are they purchased? - I was unable to find a way to purchase the boots online, they appear to only be sold in stores (why is this?).  I did a search of stores near where I live.  The closest one is a western apparel store right up the road.  So here's my impression, this western store is a place that my wife and I comment about each time we drive by, there are never any cars there, and we don't know how they stay in business.  Other friends have made similar comments.

Looking at the western store prompted another thought, these boots will probably never be purchased as a fashion item.  I know if I was looking at boots I would not go to the western store due to the stigma attached, I'd probably look online.  So the product doesn't have a big general market from what I can see.

Is the brand known to people who would likely use the product? - No idea, this would need to be further researched.

Why buy McRae boots over a competitor? - Again no idea.

This is just a start, and these are some of the things we need to think about when looking at companies.  I know I'm guilty and have been of paying lip service to the fact that stocks are companies.  Heck, this post is more of a reminder to myself than anything else.  I think as investors we need to look at a stock as a business first, and the financial component as just that, a component.  I know one value investor who has been putting these sorts of questions into action is Richard Beddard over at the Interactive Investor Blog.  This is an area I want to get better at myself.

If you are interested in the financial aspect of McRae I'd check out the Whopper link above and the great post at OTC Adventures here.

Questions, comments?  Talk to Nate

Disclosure: I make a small commission if you buy the Sleuth Investor through Amazon.com.  There is no markup on the book if you visit through my link verses going to Amazon.com directly.  I purchased this book on my own on the recommendation of someone on the Corner of Berkshire and Fairfax message board.

Adams Golf gets a buyout and other net-net thoughts

I saw this morning that Adams Golf (ADGF) received a buyout offer at $10.80 a share, this is up from $5.54 when I first wrote about them.  I wrote in that post that Adams Golf had both a margin of safety and a catalyst, plus they were trading very close to NCAV.  I wish I could say that I am sitting on a two bagger and selling my gains today but that's not the case, I never ended up pulling the trigger on Adams Golf.

So why didn't I buy in?  When looking at why I didn't invest in Adams Golf investment I can identify two mistakes I made:

1) I mis-identified the margin of safety.  

When I looked at Adams Golf I was thinking about the company as a net-net.  I was looking for balance sheet safety and a tangible liquidation value.  I wasn't looking at liquidation value because I thought the company would be liquidated but because this would provide an absolute downside for my investment.

What I missed was that a margin of safety existed in the business.  The company was profitable and had a product that was well received in the niche hybrid golf club market.  I never examined the product or talked to any customers so I missed that people liked these clubs.  The products had brand value that another company in the market would want to acquire (as evidenced this morning).

2) For whatever reason the stock never felt comfortable to me.  

This is the hard one for me to quantify, but usually with an investment as I'm researching things will start to jump out at me and eventually I know the company I'm looking at is the type of company I want to own.  I never had that sense with Adams Golf, but I never stumbled on anything that would make me want to avoid them either.

This reason seems strange, especially for a value investor.  We're told over and over that the best investors are devoid of emotion, and we should learn to ignore our emotions.  I'm going to go against the grain here and say that I'm a very emotional investor.  When I see an undervalued business that fits what I'm looking for I get excited.  I get excited in the same way that I would if someone offered to sell me a successful restaurant on a busy intersection for pennies on the dollar.

Some investors can be mechanical, following checklists and investing by stringent rules.  That's not my personality, I go with guidelines and intuition.  Guidelines keep me focused, intuition is built on experience with similar businesses or similar investments.  If I can't get excited about a company or an investment I'm prone to forget about it six months later even if it's in my portfolio.  Not sure how much of my personality comes out in the blog, but I'm a pretty carefree, last minute decision, go with the flow person.  I think sometimes my investment style reflects that.  One day I'll be looking at a pink sheet company, the next a German hidden champion, then a Japanese net-net.  No reason, just following whims for value.  The advantage of this personality is that when I get excited about something I get focused and mildly obsessed.


Changes going forward?

As I've watched net-net's since the bottom of the crisis and invested in them worldwide my view has slowly changed in what makes a good net-net.  Initially my thought was that I wanted to buy $1 in cash for $.50.  This led me down the path of being attracted to cash heavy companies, shell companies, and utterly junky net cash stocks.  Some of these investments worked out ok, others not as much, and some were just disasters.

The problem was the market rarely rewards a cash position, the market rewards a business.  I had foolishly thought that since a company had a dollar on it's books the market should have that stock trading at face value.  The reality is that there is no rule governing the market that says that all companies must eventually trade at NCAV.  A company can sell below cash value forever, or it can sell above cash value forever.

In looking back at the net-net's I've owned that have done well I found that my best performance didn't come from companies suddenly trading up to asset value, but rather from improved business performance.  I can't actually think of any net-net's I've owned or followed that suddenly drifted up to NCAV for no reason, all of them had some sort of turn around, or perceived turnaround in the business that excited investors which in turn made the share price increase.

With Adams Golf I kept thinking in terms of asset safety, and less in terms of business value and turnaround potential.  Asset safety is important especially if a company is on the verge of liquidating or is burning cash and a liquidation seems likely.  If a company is profitable and has turn around prospects assets are important for a downside, but business performance is more valuable for the company to eventually trade at net asset value.

At this point you're probably wondering how the other net-net's in my portfolio look, will I be doing a wholesale purge?  Amazingly enough outside of one Japanese net-net all of the net-net's I own conform to this pattern.  They all have a downside protected by assets with varying degrees of liquidity but all have businesses that either have the potential to improve or are improving.

My last thoughts are that I've already been putting this process in place as I look for Japanese net-net's again.  I'm looking for assets that provide a downside, but my focus is on cash flow generation and hidden business value.  Hopefully I'll have a few companies to post about in the near future.

Talk to Nate about Adams Golf, or net-nets