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On Monday, Felix Salmon had some questions for value investors and he concluded by saying: “I might have some faith in the ability of value investors to find cheap stocks, but I have no faith at all in the ability of value investors to time the market.” As usual, I agree with him.

Personally, I don’t try to time the market, and the times that I have tried, I’ve been awful. Perhaps I’m a contrary indicator. Of course, even when I try to go against my instincts, I’m still lousy. I guess it’s just me.

That’s why I stick to stock-picking. As followers of my Buy List know, I’m a buy-and-hold type of guy. The Buy List has 20 stocks that I choose at the beginning of the year. Each year, I’ve only replaced five stocks, so that implies a four-year holding period.

One stock that’s been on my mind lately is Nicholas Financial (NICK). This is what I would call a deep value stock. It’s a very low-priced micro-cap and in all honesty, it probably won’t do much of anything for a bit of time. Still, I like it and I own it.

The reason I find NICK so interesting is that it’s almost a perfect lab experiment for looking at some theories of investing. First, it’s a value stock. Second, it’s a micro-cap stock. Historically, both groups have outperformed the market as a whole. This of course doesn’t mean NICK will outperform, but it has got those two characteristics on its side.

I should add that NICK isn’t just a micro-cap. It’s really micro. The company has a market value of just $33 million. Some Yankees make more than that. I was buying it last week, and trying my best not to throw the price out of whack, but it’s hard to avoid. Some days, no shares trade.

Also, NICK isn’t just a value stock, it’s a deep value stock. The shares are going for less than four times trailing earnings. The company’s book value runs $7.91 a share. Yesterday’s close was $3.26. That, my friends, is a value stock.

Why is it so cheap? Well, NICK is in the worst possible industry right now. The company makes loans for used cars. Cars sales are plunging and the credit market is frozen. NICK isn’t officially called a subprime lender, but it sort of is. The stock has dropped from $14 to $3. But there’s a lot to like about NICK, and I’m comfortable owning it. Let me explain why.

One thing that makes NICK interesting is that it actually holds its loans to term. Shocking, I know. The company doesn’t sell its loans immediately. Most of the loans it buys from dealers at a discount. NICK also originates some loans, which tend be of decent quality, but that’s a small part of its portfolio.

Here’s very generalized description of the company's financials from last year. (Please check the SEC docs for the exact numbers. I’m just using this to explain what NICK does.)

NICK has a loan portfolio of about $180 million. That carries an interest rate of 26%. Its debt is about $100 million and it paid about 6.5% on that (it’s tied to LIBOR). So we’re talking about a company leveraged 2-to-1 with $50 million coming in the door and $6 million going out. That sounds good to me. That’s a yield of around 23%. Costs for running the business take out another 10%. The real killer is provisions for credit losses. That ran about 4% last year. This year I think it will be around 7%. NICK's accounting tends to be fairly conservative. In fact, it could be over-providing, but I’m not complaining.

Earnings last quarter were 15 cents a share down from 27 cents a share a year ago. Earnings will be lousy for the next earnings report (due sometime in early November), but they will be positive. I think they’ll probably be about five cents a share, give or take. So they are making money, which is impressive in this environment.

The big driver for NICK is the provision for loan losses. The rest of its business is fairly stable. The major driver of loan defaults in unemployment. There’s a strong relationship between the jobless rate and NICK’s defaults. I think unemployment will top out around 8% sometime in 2009, maybe early 2010. The company isn’t in any danger of going under, although there will be losses for a bit. Once things start to improve, NICK ought to prosper.

If you’re tempted to buy NICK, I will warn you. You probably won’t make anything for over a year. Once the market wakes up and isn’t afraid of less liquid stocks, NICK should rally.

Disclosure: Long NICK

Source: Why I Like Nicholas Financial