Something odd is happening with prices at Wayside Technology (NASDAQ:WSTG). I will let this chart speak for me. We have seen weekly returns of 25.94% during the week commencing 3/24/14, and a weekly return of 9.45% for the week commencing 4/7/14. This compares with an average weekly movement over the past five years of 0.406% (median 0.347%), with a standard deviation of 4.73%. Thus it is clear the bullish moves of 3/24/14 and 4/7/14 are exceptional. Then we had the week commencing 4/14/14 when the weekly return was (15.12%) followed by the week commencing 4/28/14 when the weekly return was (8.14%): these bearish moves were also statistical oddities. A similar bullish move has been seen only twice in the past five years, while a bearish move of that magnitude has been seen only three times over the past five years.
Source: My Calculations & Chart
These movements are very interesting, because I calculate beta based on a five year regression of weekly closing prices of the stock versus the S&P 500 at 0.40, and adjust it for beta's tendency to converge towards 1.00 to 0.98. But the coefficient of determination for the series is 4.11%. This suggests that only 4.11% of the price movement of the stock can be explained by price movement in the market: the rest is explained by company specific factors. So I decided to have a look to see what company specific factors might have triggered this battle of bulls and bears.
On 3/3/14 there was a notice relating to the resignation of the CFO. That did not excite owners overly though the stock closed the week up 5.99%.
Then on 3/24/14 we had an article on Seeking Alpha [Pro]. On 3/25/14 we had an announcement where an experienced executive vice president with wealth of sales and channel experience and many valuable relationships was brought into Wayside Technology. The stock moved from $15.75 open on 3/24/14 to a close of $19.86 on 3/28/14 and onwards to a close of $20.42 on 4/4/14, with a further move to $22.35 by 4/11/14.
Then on 4/16/14 we had the company announcing their earnings release date, which presumably led to fear on what it might contain and caused bearish action following the exceptionally bullish prior weeks. Next, the notice of the annual meeting on 4/21/14 probably kept the shareholder focus on the company. And finally earnings were released on 4/25/14: they missed estimates of $0.24 by $0.01, which probably extended the bearish sentiment.
So it would appear that the company specific matters causing the price move was an article on Seeking Alpha Pro, together with the appointment of a new Executive Vice President. Interestingly there was a spike in volume on 3/24/14, followed by bigger spikes in volume on 3/28/14 and 3/31/14. The bearish sentiment following was likely as a result of investors returning to reality.
In my view the stock was cheap, and remains cheap. But the stock has always been relatively cheap. As reported on Reuters, over the past five years the company has traded at a high PE of 12.28 and a low PE of 9.35. Based on present normalized diluted EPS [TTM] of $1.423, we get a high target of $17.47, and a low target of $13.31. The price had shot above that range and has now returned to the "normal" range. The stock is cheap because investors demand a higher return expectation for nano-cap stocks because risks are perceived to be high.
Wayside Technology is a relatively well valued nano-cap stock, with a healthy dividend yield of over 4%. A stock trading at a multiple of 11.68 trailing twelve month earnings, which has grown earnings at an annualized rate of 14.70% over the past five years and also grown revenue at an annualized rate of 11.50% over the past five years is cheap. Add to that, a dividend yield of 4.13% to sustain investors through bearish periods and I feel quite good about the stock. A payout ratio of 45.10% suggests that the dividend is safe, particularly since they went through the financial crisis paying a regular quarterly dividend, unlike several I could mention. And the fact that the dividend was $0.10 per quarter in 2003, and is $0.17 today shows management intent to grow the dividend in-line with growth over time. The question to ask is whether the stock is cheap on a risk adjusted basis.
When looking at this data above, I would like to inform readers that Wayside Technology has a current market capitalization of $78.9 million. It is a very lightly followed company and so it is probably best to ignore forward P/E and growth expectations: Reuters includes estimates from only one analyst for the stock. And while one well researched view might be worth a lot more than several poorly researched views, it cannot be said to reflect market expectations. It is well worth taking the time to look at the company to form your view on it.
This is how Wayside Technology describes itself:
The company operates through two divisions: Lifeboat, which is a dealer for international specialty software and TechXTend, which seeks to help customers save time, make money, and increase operational efficiency.
In my view Wayside Technology has carved out a neat niche for themselves. And while they are not tomorrows mega-cap, their past performance suggests that are capable of growing within their niche, and are able to respond to well competitive pressure.
So the dividend is nice, the valuation looks cheap. But where would Wayside Technology be rightly valued on a risk adjusted basis.
Earnings over the past five years have trended upwards nicely with normal signs of cyclicality. Today trailing twelve month earnings are at $1.42, but I normalize it to trend at $1.35 on account of cyclicality. This reflects what I call "sustainable earnings", which represents the level of earnings which can be grown over the long-term in line with industry growth rates.
How much of this is actually returned to shareholders?
The present dividend yield of 4.13% represents a payout of 45.1% of earnings. However, over the past five years, shareholders have suffered dilution of 2.24% on account of the employee and other issuances. Thus, the annualized dilution has been 0.44%. The value returned to shareholders, net of employee issuances, is estimated at 3.69% (4.13% less 0.44%), and thus I will estimate the forward payout at 40% (3.69%/4.13% * 45.1%). The remaining 60% will be reinvested in growth.
Then we get to beta. Reuters reports a beta for the stock of 0.92. I calculate raw beta based on a five year regression of weekly closing prices of the stock versus the S&P 500 at 0.40, and adjust it for beta's tendency to converge towards 1 to 0.98. But I do note that the coefficient of determination for the series is 4.11%. This suggests that only 4.11% of the price movement of the stock can be explained by price movement in the market: the rest is explained by company specific factors. In such circumstances it would be irresponsible to use beta to determine a target rate of return.
When I look at the S&P 500, I use a return expectation of 10.25% based on a long-term forward risk free rate of 4.50% and an equity risk premium of 5.75%. This is the return I expect from a market which I expect to grow earnings at a long-term rate of 6.25% (made up of equal weighted 8% nominal potential Global GDP growth and 4.5% nominal potential U.S. GDP growth). The growth risk premium I demand is thus 4% (10.25% less 6.25%). In the case of Wayside Technology, I expect 60% of earnings to be reinvested. And I expect the company to earn a return on incremental equity invested of 17.5%, in-line with the average return on equity over the past five years as reported on Reuters. Thus, I expect growth of 10.50%. I will set my return expectation from the stock at 14.5%, being a 4% growth risk premium over my growth expectations.
Mathematically, the worth of Wayside Technology is estimated as [1 + Long-term Growth Rate] * Sustainable Earnings * Adjusted Payout Ratio / [Long-term Return Expectation-Long-term Growth Rate]. Using estimates as stated above, I would value the share at $14.92 [110.50% * $1.35 * 40% / (14.50%-10.50%)].
As reported on Reuters, over the past five years the company has traded at a high PE of 12.28 and a low PE of 9.35. Based on present normalized diluted EPS of $1.423, we get a high target of $17.47, and a low target of $13.31. The $14.92 price I calculate is within this band.
This suggests that on a risk adjusted basis, Wayside Technology is not as cheap as it first appears at first glance.
The destination of market efficiency wanders through the torturous path of market inefficiency. I personally tend to walk the path of large and mega-cap stocks where price discovery is facilitated by strong liquidity.
But what should the nano-cap investor do next? A nano-cap investor able to stand the pain of price volatility as prices work their way towards equilibrium represented by value could buy.
The data for Wayside Technology suggests that the odds are statistically stacked against the longs: liquidity and the absence of efficient price discovery are against you. Notwithstanding that, in my view, past performance and low levels of earnings volatility & earnings beta should allow investors to set a far lower return expectation than the 14.50% I have used: using a 13.50% return requirement, the stock would be rightly priced at near $20. Put differently, it ought to trade at over the high five year high PE ratios at a multiple of approximately 14. With the large recent weekly declines to statistically unusual levels, we could see a bounce towards $17.50: the area at the top end of the five year high PE.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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