Five Stocks to Watch in 2008

by: Dan Weiss

I look for companies in one of four different buckets in my portfolio: 1) under-followed companies with little or no analyst coverage, 2) stocks trading at significant discounts to their true worth, 3) companies that are misunderstood by the Street, and 4) companies involved in a reorganization, spin-off or restructuring. I also like companies which have significant insider ownership, although this is not a requirement for investment, and securities that most importantly trade at an attractive valuation. For subscribers who have looked at my portfolio you will notice a balance of some growthier names along with your typical Graham & Dodd value stocks, which allows the portfolio to participate in many different types of market cycles while adhering to a valuation discipline.

The five stocks that I am briefly highlighting today I have just started research on, but are securities which I find interesting and could potentially be added at some point to the portfolio. In addition, I am conducting research on several other names which are not included in this post.

1) Allied Defense Group ($5.01) Symbol: (ADG) : Defense company focused on the development and marketing of ammunition and weapons along with electronic security. The company is completing a two-year restructuring program which has resulted in the sale of some lower performing units and the recapitalization of the firm. The stock has steadily declined over the past year from over $20 per share to $3.75 and has recently bounced back to the $5 level. The company's backlog was recently announced to have increased to a level of $143 million from just $42 million a year ago, and the company recently announced another $10 million ammunition deal in the past week. Earnings for the company over the past year have been severely impacted by the restructuring resulting in a large loss. However, expectations are for the company to convert some of the large backlog into revenues over the next one to two years resulting in a return to profitability. I am not yet at the stage of investing in the company as I would like to get a clearer understanding of the company's mid- to long-term business plan prior to a potential investment in ADG.

2) L.S. Starrett ($16.29) Symbol: (NYSE:SCX) : Company was started in 1880 and sells over 5,000 products ranging from items such as saw blades to chalk products to drill rods among many others, primarily to the metalworking industry. The stock trades with a relatively attractive 2.4% dividend yield, had a relatively strong 11% increase in revenues in 2007, solid and increasing operating cash flows and is selling at just 4x EV/EBITDA and at 0.6x book value. The stock looks very attractive on a valuation basis and I'm now completing the more qualitative assessment of the company.

3) First Marblehead ($12.66) Symbol: (NYSE:FMD) : The company's stock has been hammered in recent months from a level of $57 in early 2007 to its current level of $12.66. First Marblehead securitizes student loans for organizations. The company is reliant on a few costumers, and about 40% of originations are completed through JP Morgan (NYSE:JPM) and Bank of America (NYSE:BAK) who very possibly could cease to be customers at some point in the intermediate future. The company was able to complete a sizeable securitization in September, but has not been able to do one since that time due to the poor shape of credit markets. The largest near-term issues with this stock are that the credit agencies are very likely to downgrade some of the tranches of First Marblehead's securitization and that, as mentioned before, no securitizations have been made in the most recent period. My initial thoughts are that the company will be able to once again securitize loans at some point in the first half of 2008, and that their $4 per share in cash will enable them to withstand the current credit crunch. However, significant risks do exist with potential write-downs or downgrades by the credit agencies.

4) Aehr Test Systems ($5.75) Symbol: (NASDAQ:AEHR) : The company is involved in testing and burn-in of equipment for semiconductors. The company has recently introduced its next generation of wafer contact systems and is experiencing the start of a product upgrade cycle. The company is profitable, has over $1 per share in cash, no debt and a solid ROE of 12%. The key issues that I will need to overcome are the low liquidity in the stock (average volume is under 10,000 shares) and the cyclicality of the industry.

5) Ninetowns ($3.42) Symbol: (NASDAQ:NINE) : This is an old holding of mine which I sold on the run-up in share prices for the stock earlier in the fall. The stock has recently returned into the mid $3's and is a cash play. The latest cash level reported was about $3.40 per share but I would caution this as it was 1st quarter data, and I would not be a buyer until/if the stock approaches the $3 level. The company has a couple of potential catalysts going into 2008 in its B2B initiatives as well as its deal with the Chinese government to begin servicing import/export e-filing software. Note that this company will likely be reporting updated earnings in the next couple of weeks and I hope to get some clarity on the status of the above potential catalysts.

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