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Jae Jun
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Founder of Old School Value (www.oldschoolvalue.com). Fundamental Stock Analyzer & Valuation Tool for Value Investors to Save Time & Make Money ======================== - Are you spending a lot of time manually gathering and inputting data into spreadsheets? - Are you finding it... More
My company:
Fundamental Stock Analyzer
My blog:
Old School Value
My book:
The Ultimate Guide to Stock Valuation
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  • 3 Of The Most Overpriced Stocks With Real Downside Risk

    I don't short.

    I like to copy Buffett in that regard.

    Charlie and I (Buffett) have both talked about it. We probably had a hundred ideas of things that would be good short sales. Probably 95 percent of them at least turned out to be, and I don't think we would have made a dime out of it if we had been engaged in the activity. It's too difficult. The whole thing about 'longs' is, if you know you're right, you can just keep buying, and the lower it goes, the better you like it, and you can't do that with shorts. - Warren Buffett

    The richest investor in the world got to where he is not having shorted a thing. But with less to buy in the market, I want to turn my attention to see what was expensive.

    Not to short or tell people to short, but just to see what was out there.

    It seems like Goldman Sachs regularly releases a list of stocks with the most downside based on their valuations. Since most of the stocks on their list is only overpriced by 15% or so, I figured I'll give you my version of what overpriced is.

    Searching for Overpriced Stocks

    I started out by being lazy and looking up stock with a PE greater than 100. Then I realized that some of these listed companies may have crazy valuations, but some of them had real legs to run. So my search is based on a mix of unrealistic EV/EBITDA and negative ROE.

    Fundamental numbers, valuation metrics, intrinsic value targets and certain charts come from the Old School Value Stock Analyzer.

    Zilllow (Z)

    Real estate information website and app.

    Recent Price: $73.48

    What It's Worth: No more than $20 (even with extreme growth assumptions)

    Downside: 80%

    Why I Don't Like it and Why It's Overpriced

    Regular share dilution by issuing shares.

    Another round of share issuance was completed in the third quarter of 2013. Latest share count shows 39m shares outstanding compared to 30m in 2012. That's a 30% increase of shares.

    Insiders consistently exercise options.

    Zero open market purchases. If insiders are unwilling to buy, it shows that the expectations baked into the current stock price is too expensive for the insiders.

    (click to enlarge)Zillow Insider Transactions | Source: Morningstar

    No proven operational history.

    I get that Zillow is a growth stock, but is growth far more important than running the operations properly? The revenue growth is slowing down. Sales in the TTM is 49% higher than the previous year. A big drop from the 120% and 77% from first two year of being pubic.

    High growth of intangibles.

    A lot of acquisitions are being made to increase the offering. Zillow used to be a real estate pricing company, but with the web 2.0 revolution, it is offering more services and reaching into different markets to continue growth. Intangibles have gone from $76m in 2012 to $124m in the TTM.

    Core business is unstable.

    I am no real estate expert but from a business point of view, when a growth company, still in its early stages has to continue acquiring companies, there is no core strategy. It's management trying new things and trying to expand into different markets to see what works.

    Fundamentals are Through the Roof.

    Call me blind or stupid, but I have no idea how to interpret these numbers to see Zillow's upside.

    (click to enlarge)Zillow Valuations | Source: Old School Value

     

    Black Diamond (BDE)

    Makes outdoor products and apparel. Think of Columbia Sportswear and The NorthFace.

    Recent Price: $13.20

    What It's Worth: $7 max, and that's because I'm nice.

    Downside: 52%

    Why I Don't Like it and Why It's Overpriced

    Horrible business execution.

    I don't see a single shred of competitive advantage.

    Margins have dropped considerably, the company is showing losses, it is losing money, and ROIC is negative.

    Share Dilution.

    A common issue with overpriced stocks is that shares are diluted constantly.

    (click to enlarge)BDE Share Dilution

    Share count has gone from 16.9m in 2009 to 32.4m TTM. That's a dilution of greater than 100% in 4 years. Compare that to a company like Peerless Systems (PRLS) that has bought so much of it's own shares that there will be nothing left soon.

    (click to enlarge)PRLS Buys Back Shares Like Crazy

     

    Slow Moving Inventory.

    Slow moving inventory isn't necessarily a bad thing, but if it takes 1.5x to 2x longer to clear the inventory compared to competitors, there is a serious operating deficiency.

    On the bright side, it shows that there is room for improvement and the stock could benefit, but margins are razor thin, and there is no room for mistakes for a small outdoors specialty retailer like Black Diamond.

    Low Piostroski Score.

    Black Diamond scores a 3 in the TTM vs a pathetic score of 2 in 2012.

    (click to enlarge)A Lowly Piotroski Score

    The three points come from

    • positive operating cash flow in the TTM
    • cash flow from operations greater than ROA
    • asset turnover is higher than in 2012
    Yelp (YELP)

    Online business review website and app.

    Recent Price: $63

    What It's Worth: $10 even with crazy optimistic assumptions. See below.

    (click to enlarge)Fundamentals are missing in the stock price

    Playing around with the EBIT calculator, to even justify the current stock price, the normalized revenue has to be in the $1b range with 20% margins and an EBIT multiple of 20.

    F.Y.I. revenue for the TTM is just $203.5m so you can see I am being generous.

    Downside: 81%

    Why I Don't Like it and Why It's Overpriced

    There are no fundamentals.

    The obvious thing to me is that Yelp does not trade on fundamentals. Recall when I wrote about Tesla.

    Stock price = fundamentals + emotions

    That's what I'm seeing with Yelp at the moment.

    If you were offered the chance to buy out a private business with Yelp's numbers, what would you do?

    I'd slap the seller in the face.

    The numbers look worse than a non-profit company.

    • no profit
    • negative margins
    • share dilution
    • negative flow from operations
    • negative ROE (but surprisingly positive CROIC)
    Relentless Insider Selling

    It's always been the trend for successful IPO's.

    (click to enlarge)YELP Insider Activity

     

    Heavy Competition

    One of the biggest competitors is now Google Maps. With so many Android devices already preloaded with maps, it's a given that it will eat into Yelp's mobile space.

    How?

    Google maps and navigation is now integrated, and the natural flow when you try to look up the direction for a restaurant or a business is to type the address in. What happens now is that reviews pop up once you've entered your destination making it easy to decide on the spot rather than fire up the Yelp app.

    A Word on Overpriced Stocks

    The majority of companies that showed up in my search were related to software and the internet. Maybe I'm just not smart enough to be able to see far into the future. These three stocks all have high downside risk and need things to continue going right.

    The most surprising thing for me is that Jim Chanos took a long position in Yelp. One of the best short sellers buying Yelp makes no sense to me so I'm going to assume that my valuations are all wrong here.

    But you know what the best thing is?

    Despite how wrong I could be, I am not obligated to purchase or swing at any of these companies.

    I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There's no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it. - Warren Buffett

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: Z, BDE, YELP, Short, overvalued
    Nov 24 4:28 PM | Link | Comment!
  • IEC: Capable Management But Shareholder Friendly?

    Verdict

    • Management: B+
    • Growth: B-
    • Moat: C
    • Risk: C
    • Valuation: B+
    • Overall: B-
    Business Description from the 10-K

    IEC Electronics (IEC) is a provider of electronic manufacturing services (EMS) to technology companies. The Company specializes in the custom manufacture of circuit cards, system level assemblies, a range of custom cable and wire harness assemblies, and precision sheet metal.

    Their business segments consists of Military and Aerospace, Industrial & Communications, Medical and other.

    Why is it Cheap? / Is it Cheap?

    The initial question I start with, but in this case, nothing jumped out screaming value.

    On a side note, IEC is ranked number 3 in the 2011 Forbes Best Small Companies list and the companies that show up on this list are usually growth orientated which is why I can't conclude as easily whether it is cheap or not.

    Management Check

    The best place to get information about management is to read the Proxy. The code for the Proxy document is "DEF 14A". You can then automatically track the SEC filings and use the method described in the tutorial for detecting changes in SEC documents.

    Here are some points regarding management and their decisions.

    • Insider ownership is high at 16.59%
    • CEO is also chairman of the board
    • Huge increase in salaries for insiders in 2011 vs 2010. CEO compensation increased 75%. Although performance targets were met, most of these numbers were possible only through acquisitions instead of actual organic business growth.
    • Management does not buy back shares or buy their own stock even at low prices.

    Another piece of interesting information is the debt acquired to finance acquisitions. The interest rate on these loans is between 2.5 to 4%. With such low interest rates, using debt instead of using their cash on hand is a no brainer. Nice move by management.

    Growth Plans

    The murky aspect of any analysis. Always filled with what if's.

    As a smaller company in a highly fragmented industry, acquiring companies to grow is a must and IEC has shown that it will acquire. As mentioned above, they have gone about it smartly the past couple of years.

    IEC also has some additional potential because they do business in several segments. Revenue is diversified and if IEC locks down additional contracts for each segment, that should help drive further business.

    Another aspect that is advantageous for IEC is that none of the their competitors are "giant" corporations, but on the flip side, it will be equally difficult for IEC to become a giant. At some point it will plateau.

    Strategic Advantage/Moat

    Companies like IEC could claim all sorts of strategic advantages, but in reality there is none.

    By none, I mean none of the claims are durable. A competitor could easily do the same thing. Here are some strategic advantages the company claims. You judge for yourself.

    • Company strategy is to focus on creating manufacturing partnerships with new and old OEM's. This allows IEC to have a broader product line without a need to buy out every company.
    • Another way of looking at it, IEC depends on having really good relations with customers. Help the customers save money, and then make it difficult for the customer to switch to another company because the service is so good. If a customer is saving money and happy with IEC, why would they want to change?
    • By having multiple manufacturing partnerships, rather than just supplying a certain part of a product, IEC can provide parts for the entire supply chain and build the entire product for the customer.
    • It would be better to be the low cost provider in this industry, but IEC is not.
    Competitor Discussion

    There are plenty of companies, both private and public, that provide the same type of service.

    With a lack of durable strategic advantages as explained in the previous section, it's expected that plenty of competitors exist.

    The one thing I can see that sets IEC apart from their competitors is their military and aerospace business segment. Due to regulations, the government is not allowed to purchase from suppliers outside the USA.

    Risks

    Always protect the downside. Apply risk protection methods first and the upside will take care of itself.

    Refer to the risks associated with the company.

    Inventory Risk

    • Does not hold too much inventory (could be an advantage actually).
    • Has to purchase raw materials up front or receive them from customers. Uses turnkey services which could be a problem is the supplier does not have the required parts. Also it means IEC has to purchase small quantities regularly which is more expensive than buying in bulk.
    • Obtained 53% of materials from two suppliers. If a relationship broke down with any one of the two, it would cause big delays and losses.

    Concentrated Customers

    • Concentrated customers. In 2011, Sigma represented 16% of revenue, GE represented 10% of revenue and the top 5 customers make up 45% of revenue.
    • 56% of revenue come from military and aerospace. Any reductions in military and aerospace budget will affect IEC.
    • Customers do not commit to long term production schedules. They could cancel, delay or change orders any time.
    • Solvency will be an issue if they lose just one major account.
    Valuation

    IEC's business has turned around since 2005. Margins have dramatically increased compared to early 2000's and the company is cheap on a P/S basis. P/B and P/Tangible Book is on the average side.

    ROE has been excellent, but the use of debt has been helping. ROE since 2005 has been 23% average. Compare with CROIC which is 17% during same period. Still high but the number has dropped to 8.3% in 2011.

    Long term debt has increased due to the acquisitions, but with such low interest rates, it shouldn't be a problem.

    Inventory turn has decreased from 2010 to 2011. This only confirms that the top line growth was from acquisitions.

    Share dilution seems to be an issue. Increases by about 5% annually.

    Has an extraordinarily high accrual buildup. Accounting isn't very good. Red flag.

    Using a couple of quick stock valuation tools to check out what the market is expecting from the current stock price;

    • Reverse DCF shows the market is expecting about 5.5% growth with a 12% discount rate.
    • A reverse Graham valuation with EPS of $0.68 so the expected growth to be 1%.
    Possible Catalysts

    Some potential business developments that could help IEC.

    • Government defense budget is not cut
    • USA gets involved in another war (hope not)
    • Acquisitions proves to do well
    • Partners with several additional suppliers to stabilize its distribution channel
    • Diversifies customer base without losing sales
    Other Pieces of Info of Interest
    • Was created through a merger in 1990
    • Founded in 1966
    • Acquisitions in each of the past 3 years
    • 33% higher backlog in 2011 vs 2010
    • Acknowledges that employees are biggest assets
    • Good relations with employees. No work stoppages, no unions. Only 1 review on glassdoor.com but it's a good one.
    • Certain "covenants in IEC's credit agreement with Manufacturers and Traders Trust Company restrict the Company from paying cash dividends."
    Conclusion

    Management looks capable but I have to question their shareholder friendliness. The company will never pay a dividend, salary spikes are enormous and there will be consistent share dilution without any buybacks or open market purchases.

    It feels like the management team is more content with their corporate lives and benefits vs rewarding shareholders.

    Growth is limited and will mainly come from acquisitions. Business has no moat with plenty of risks to consider.

    Ultimately, the company is a little too much on the risky side, even though valuation based on earnings is low.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: IEC
    Feb 14 1:21 PM | Link | Comment!
  • Downside Protected with this Profitable net net

    ADDvantage Technologies Group, Inc., through its subsidiaries, distributes and services a line of electronics and hardware for the cable television (OTCPK:CATV) industry. The products, the Company sells and services are used to acquire, distribute, receive and protect the communications signals carried on fiber-optic, coaxial cable and wireless distribution systems. Its customers provide a range of communications services, including television, high-speed data (Internet) and telephony, to single family dwellings, apartments and institutions, such as hospitals, prisons, universities, schools, cruise boats and others. The Company’s operating subsidiaries include Tulsat Corporation (Tulsat), Tulsat-Atlanta LLC, ADDvantage Technologies Group of Nebraska, Inc. (doing business as Tulsat-Nebraska), ADDvantage Technologies Group of Texas, Inc. (doing business as Tulsat Texas), Jones Broadband International, Inc. (doing business as Tulsat-West) and ADDvantage Technologies Group of Missouri, Inc.

    Why is it Cheap?

    • boring business
    • reseller of equipment to companies such as comcast, direct tv, centurylink etc
    • industry risk. Consolidation could mean loss in revenue. Customers have slowed down their network upgrades.
    • builds up inventory of new and used equipment to sell
    • not followed or held by any of the big boys

    Management

    • not much insider buying even at these low levels
    • total exec compensation was 2.4% of revenue in 2010. Below my 3% threshold so good.

    Growth

    • not much room for growth. But with such a healthy balance sheet, their returns does not have to be high to produce growth.
    • market is assuming that the max it can do is 4% growth by reverse engineering prices
    • acquisitions will help with growth. Their acquisitions are small and targetted based on the target's distribution channel and product offerings.

    Moat

    • Niche player. Can't beat the OEM's in providing equipment, but does take advantage of the many black holes left behind by them.
    • sustainability is absent though. A new competitor with money could come overnight and take them out.

    Competitors

    • competitive business
    • trading at net net value means there are better competitors otherwise it wouldnt trade below asset value

    Risks

    •  inventory valuation. If it had to be liquidated, how much would it be worth?
    • Strategy of building up inventory – very low inventory turnovers. All costs money and working capital.
    • New agreement with CSCO isn't the best. They now have to resell CSCO products which will lower margins.
    • no dividends. just builds cash.
    • dont see much chance of buyout for such a company

    Valuation

    • no matter what I try, I keep coming up with a low range of $2.80 to $3 which gives 34% upside potential as a minimum.
    • Operating at low end of business cycle as the industry has slowed down. Cash flow will reduce.
    • I'm estimating EPS of $0.28 for 2011 without doing much more work.

    Catalysts

    • Industry starts spending for network upgrades
    • (hmm can't think of many catalysts other than being cheap)

    Conclusion

    Quality net net currently operating at the down cycle. Room for revenue and cash flow growth if the industry picks up. A bit too reliant on external factors but management has been able to handle the business very well. Great ROE, CROIC for a net net. Not many profitable ones out there. Business is easy to understand and the biggest risk really comes down to whether the inventory is really worth what it is.

    I wouldn't call it a value trap because their business model is consistent.

    Verdict

    • Management: B
    • Growth: C
    • Moat: C
    • Risk: A
    • Valuation: A

    Buy a small position and wait for a long time to play out.

    Other links on AEY

    http://www.whopperinvestments……logies-aey

    seekingalpha.com/articl…..good-price

    seekingalpha.com/articl…..addvantage

    seekingalpha.com/articl…..-micro-cap

    Tags: AEY
    Jan 06 8:59 PM | Link | Comment!
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