"Reversion to the mean is the iron rule of financial markets" John Bogle
"Many shall be restored that now are fallen and many shall fall that now are in honor." - Horace, published in Security Analysis
Post motivated by recognizing our most productive efforts should NOT be focused on finding the best stock using traditional metrics. Instead, the most mispriced bets placed by irrational Mr. Market regardless of its quality or net reported assets.
Mr. Market sets odds, probabilities on a stock's future outcome. Yet, human behavior creates irrational pricing. But, changes in intrinsic value are slow. Hence, this creates investable windows of opportunities.
A stock may miss earnings expectation by 10 percent and lose half its market value. This is likely an irrational price swing. Perhaps creating a short window of opportunity to invest short or longer term until the odds' maker (Mr. Market) adjusts its error. It should not matter if it's operationally the worse company in its industry. But instead, if its price variance from its value to other potential investors or companies that can benefit from their assets... "there are no bad assets just bad prices".
Many ideas won't have an obvious margin of safety in the traditional sense of Graham's definition. Yet a dramatic price drop could create an investable window of opportunity even if it's a decaying assets base. Here's a recent example from last week, I was looking at the apparel store industry to post comments on The Wet Seal, Inc. (NASDAQ:WTSL). Body Central (OTCQB:BODY) is a very financially ugly stock in business since 1972. To make a long story short, there were plenty of opportunities to pick up shares at or below .65. M&A firms saw value and started picking up more shares. But it wasn't until Friday that the stock moved up 38% with no news. Just an example of how even without the traditional Graham's margin of safety there may be value in the brand, leases or other intangibles at the right price. Body's 52 week change is over negative 90%.
Thus, focusing on the markets overreaction may provide the best avenue for alpha creation.
The Wet Seal is an ugly stock selling in a horrible industry, mall based women apparel. Undoubtedly it's risky. Yet a potential high probability outsized gain makes this deep discounted value idea a superior investment. Trading (05/30/14) at a historical low price of $0.86 (EV per share is $0.44), May 2004 $5.83, May 1999 $12.31, May 1994 $1.50, May 1992 $5.00. WSTL enters the second half with a more refined and productive base.
Based on the May 27 conference call, several changes are catalysts for future price moves expected to be realized over the second half of the year. Here's a list of improvements yet to be realized in the stock price:
- Arden B division fully closed and transitioned during this period freeing up 1.3 million of annual costs to be allocated to more productive assets
- Lease expirations for nonproductive locations freeing capital at no additional costs
- 54 Arden stores now fully set with Wet Seal and Wet Seal Plus merchandise in time for the back-to-school selling season. 31 of these locations will feature Wet Seal Plus (new concept) and the remaining 23 will feature Wet Seal product. Wet Seal Plus now introduced with tremendous conviction and potential for both intermediate and long term growth.
- Three of the newest Board members have a wealth of experience in social, digital and e-commerce.
- Wet Seal will become a featured merchant on the Oink website. This will offer payment technology developed for kids and teens.
- Board of Directors took action to lower directive compensation by 20% and decreases the Board size from 9 to 7members.
- Lease expirations for non productive stores with ability to walk away at no additional costs.
- The quarter ended with over $80 million of liquidity between cash and bank line availability. Continued focus on preservation of the company's financial strength.
A warning, the macro environment for mall based women apparel MAY not be different this time. Is mall traffic permanently challenged? But even after that said investors can rationalize an arbitrage play (stock rental), not a buy and hold retirement investment. But I can't know. I do know the WSTL is one of the cheapest stock in the market based on multiple metrics.
These are additional financial reasons to consider WTSL:
- Aggressive 5% share count reduction from 88.50M on Q1 2013 (reported 05/04/13) to 84.11M for the most recent Q1 2014 (reported 05/04/14). Furthermore a 15% share count reduction from 2011 share count of 99.26M. 52 week price change is -83.60%. 52 week high was 5.20 now $0.84 per share, enterprise value per share is $0.44.
- Reasonable F score indicating relatively sound business, not great at this time. Fantastically low valuations such as:
EV/GP = 41.04M/135.24M = .30. or $3.637439 in gross profits for each share with current EV at .44.
EV/Sales = .08 or or $13.62 in sales for each share purchased with current EV at .44.
- Chuck Royce aggressively purchased the stock for the quarterly period ending 03/31/2014. 845,000 shares were purchased for an average price of $2.04 to bring their total holding to 908,200 shares.
Recent positive insider activity is an anomaly for the women apparel industry.
WTSL positive insider activity:
Wet Seal is a mall, off mall,and online women apparel retailer with 532 stores in 47 states and Puerto Rico. Wet Seal was founded in 1962 and is based in Foothill Ranch, California
Market Cap: 70.65M , Enterprise Value : 41.04M
Price/Sales : 0.14 ,Price/Book: 1.57
Enterprise Value/Revenue: 0.08
Revenue (ttm): 506.42M , Revenue Per Share (ttm): 6.00
Qtrly Revenue Growth (yoy): -16.90%
Gross Profit (ttm): 135.24M
Total Cash (mrq): 54.49M ,Total Cash Per Share (mrq): 0.65
Total Debt (mrq): 21.52M
Current Ratio (mrq): 1.85
Book Value Per Share (mrq): 0.55
52-Week Change: -83.06%
Shares Outstanding: 84.11M ,Float: 60.70M
% Held by Insiders: 3.01% ,% Held by Institutions: 79.60%
Short % of Float : 20.70%
Disclosure: Long WTSL, CODAF
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.