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As a quantitative investment firm, numbers come first here at Sabrient. We spend our time analyzing the data that our research has shown to have predictive powers for a stock's price potential, and we rank those stocks accordingly.

During one of the rare cloudy days in Santa Barbara this week, I set about using Sabrient’s filters to find a long candidate for my portfolio. First, I used Sabrient’s web-based research tool MyStockFinder to produce a list of high growth companies that have no debt, and I specified that the stocks be ranked as a “Buy” or “Strong Buy” by Sabrient.

The search returned a list of growth companies, but several had shrinking quarter-over-quarter earnings. I wanted companies with proven track records of earnings growth and ones that showed promise of continued growth. To this end, I added a filter that restricted the search to stocks that had increased EPS every quarter for the past two years.

These filters returned just two stocks:

Ticker

Company

Debt

Long-term Growth

P/E (Trailing)

P/E (Forward)

(NASDAQ:RBCN)

Rubicon Technologies

0

38%

7.37

6.892

(NASDAQ:JOBS)

51Job Inc.

0

23.3%

43.69

28.48

Based solely upon its high P/Es, I rejected JOBS and decided to investigate RBCN in more detail to see how it fit my other personal “buy” criteria: comparing the historical EPS, P/E and P/B with present valuations.

RBCN fit so well that I had to look for reasons against buying it.

Date

Price ($)

EPS ($/Share)

P/E (ttm)

P/B

07/29/09

11.82

-0.15

NA

2.38

11/03/09

15.12

-0.1

NA

3.05

02/09/10

15.78

-0.04

NA

3.24

04/29/10

27.2

0.07

NA

5.52

08/05/10

30.25

0.18

291.36

6.18

11/04/10

23.99

0.35

42.1

3.3

02/16/10

17.26

0.64

13.47

2.34

05/05/11

28.51

0.8

14.26

3.6

Present

14.61

NA

7.37

1.62

I ran this check to ensure that such low P/E and P/B values are not the norm for this stock. Since RBCN has previously traded at much higher valuations, I concluded that either the stock is undervalued by the Street — making it a good undervalued growth buy--or that other factors might be putting downward pressure on the price.

To begin searching for such factors, I looked at the company's historical Return on Assets (ROA), Return on Equities (ROE), and Return on Sales (ROS) to determine how efficiently management has been running the company, and how the margins have been changing over the past two years. Here is what I found:

Date

Price ($)

ROA (ttm)

ROE (ttm)

ROS (ttm)

07/29/09

11.82

-6.34

-6.55

-32.67

11/03/09

15.12

-10.14

-10.39

-76.1

02/09/10

15.78

-9.47

-9.71

-52.34

04/29/10

27.2

-4.1

-4.25

-16.17

08/05/10

30.25

2.22

2.3

6.48

11/04/10

23.99

9.25

9.63

23.17

02/16/10

17.26

17.43

18.35

37.39

05/05/11

28.51

23.56

24.96

45.88

Present

14.61

TBD

TBD

TBD

The monotonically increasing values for ROA, ROE, and ROS indicate that the management is using its capital effectively to generate earnings and that margins on their products are getting higher as the company grows and becomes more efficient.

After determining that RBCN does not have defective management, I turned to the company’s 10-K to find the source of the downward pressure. As a mathematician, this is the most loathsome part of stock research so I will cut to three relevant parts of the 10-K.

Customers as a downward pressure:

In 2010, sales to LG Innotek, Tera Xtal Technology Corp., and Iljin Display Co, Ltd. represented approximately 17%, 15% and 14% of our revenues, respectively. In 2009, sales to Crystalwise, Tera Xtal Technology Corp., and Iljin Display Co, Ltd. represented approximately 20%, 17% and 11% of our revenues, respectively. If we were to lose one of our major customers or have a major customer significantly reduce its volume of business with us, our revenues and profitability would be materially reduced unless we are able to replace such demand with other orders promptly. We expect to continue to be dependent on our significant customers, the number and identity of which may change from period to period.

In short: RBCN has three main customers, none of whom it can lose and expect to remain profitable.

Competitors as a downward pressure:

We participate in an innovative, specialized and competitive industry. The products we produce must meet certain demanding requirements to succeed in the marketplace. Although we account for a significant percentage of the total market volume today, we face significant competition from other established providers of similar products as well as from potential new entrants into our markets.

In short: RBCN has competitors who threaten to steal its market share if it does not stay innovative.

Regarding intellectual property:

To protect our technology, we have chosen to rely primarily on trade secrets rather than seeking protection through publicly filed patents. Trade secrets are inherently difficult to protect. While we believe we use reasonable efforts to protect our trade secrets, our directors, employees, consultants or contractors may unintentionally or willfully disclose our information to competitors, whether during or after the termination of their services to our company. If we were to seek to enforce a claim that a third party had illegally obtained and was using our trade secrets, it would be expensive and time consuming, and the outcome would be unpredictable. In addition, courts outside the United States are sometimes less willing to protect trade secrets than U.S. courts. Moreover, if our competitors independently develop equivalent knowledge, methods and know-how, it will be more difficult for us to protect our intellectual property and our business could be harmed.

In short: RBCN’s intellectual property is protected by trade secrets rather than patents. This could be problematic in the future if competitors begin to use RBCN's technologies.

These three issues are potentially problematic, but can be given less influence if the investor is aware of them and tracks their progress. I will address each issue, as well as my rationale behind giving them lower priority than I give to the numbers from the tables above.

  • The rapport Rubicon has with LG (NYSE:LG), Tera Xtal, and Iljin is presumably solid as they have grown the sapphire wafer technologies together over the past several years.
  • Despite the entry of new competition in the market, Rubicon remains well positioned to profit from their already-solid foothold, and have exhibited that the company is confident in its ability to innovate ahead of the curve.
  • Rubicon has begun to obtain patents for some of its technology, and due to its significant head start and R&D capacity, it is likely to innovate at a rate that renders past technologies less useful by the time the competitions discovers them.

After scouring the 10-K, I make two last checks based on metrics we use at Sabrient. First, we assign scores to a company’s accounting practices, based on whether they are conservative or aggressive. RBCN received a “Moderately Aggressive” ranking. It is not enough to keep me away from the stock, but it is something worth keeping an eye on. Second, I see that the short interest is a staggering 52.40% of float. This makes the stock a huge candidate for a short squeeze as soon as there is some upward momentum

With the accounting score and short interest as my last filters, I concluded my research on the stock. To summarize: Rubicon has increased its earnings every quarter for the past two years; it has no debt, high growth opportunities, increasing margins, a low price-to-book valuation compared to its history, and a Sabrient Buy rating. So despite its extraordinary short interest, I am unreserved in my recommendation to buy this stock.

Source: It's Time for the Longs to Cross the Rubicon