Over the last year, we have discussed many stocks that have appeared to trade at significant discounts to their intrinsic values. But lately, undoubtedly due in part to the market's rally, we find ourselves discussing previously downtrodden stocks that are actually approaching their intrinsic values. The latest example of this is Melcor (MODVF.PK), a property developer and property manager in the western part of North America.

This company operates primarily in Alberta, a province rich in oil. When oil prices are high (low), Alberta's economy is strong (weak). While energy prices are volatile, the market's (over)reaction to energy prices appears to be even more volatile, as we saw when we looked at Melcor's price to book over the last several years. At that time, Melcor traded at a 40% discount to its book value. While it's book value hasn't changed, the market value of the stock has almost doubled, bringing it to a level near its book value!

No one said being a value investor was going to be easy. In fact, I've heard several different value investors make comments about how difficult it is and how much discipline it requires to be a value investor. For example, in this Morningstar article, Larry Sarbit is quoted as recently saying that he is only 57 years old but feels like 87. That doesn't sound like a positive declaration for how easy it is to be a value investor. Obviously these market conditions are taking a toll on even the most seasoned of value investors.

Last year, while attending Prof. George Athanassakos' value investor speaker series at the Richard Ivey School of Business, I had the privilege to listen to the wisdom of Bob Tattersal, a very experienced and successful value investor. I was excited to learn that Bob was actually going to reveal his technique for finding "deep value" in securities. Then Bob said something which revealed his tremendous insight of human behaviour. Bob said, "I don't mind showing you these techniques because quite frankly, most if not all of you are not going to be able to follow my advice". Wow, that really hit me!

Benjamin Graham wrote about "net-net value plays" as situations where a company's current assets minus all liabilities (the result is called net current asset value or NCAV) is worth more than the current market capitalization of the stock. If the value of current assets is accurately stated on the balance sheet and are realizable (read more about net-net plays here), net-net plays can afford considerable protection of capital to new investors. One potential problem with investing in a "net-net" stock is if the operations of the company are net depleting assets and eroding the balance sheet to the point where the NCAV is no longer positive.

One currently available net-net play in the stock market is with GSI Group Inc. (NASDAQ: GSIG). This company designs, develops and manufactures precision laser systems for customers in the electronics, medical, semiconductor and aerospace industries. This stock was brought to my attention by an article posted on the Yes and Not Yes site, which referenced one of our articles.

Kaboose (KABFF.PK) is an online advertiser and marketer geared towards families and children. Some of the websites they run include bounty.com, babyzone.com, amazingmoms.com, funschool.com, zeeks.com and bubbleshare.com. Kaboose generates revenues through online commerce and advertising. The company has been growing revenues primarily by making strategic acquisitions of websites geared towards their target market segment.

First, lets review some of the Kaboose value indicators. The stock has a market cap of $101.5M based on the current market price of $0.73/sh. The relatively small market cap suggests that analyst coverage is likely low and could lead to pricing inefficiencies with the stock, as we've discussed here. The company is not yet profitable, however, with an equity value of $180M the price to book ratio is 0.53. Depending on the quality of the assets, the low P/B value could indicate value.

The Great Atlantic & Pacific Tea Company (GAP) is a food retailer operating 447 stores in primarily north eastern U.S. states. GAP sold its Canadian operations to Metro Inc. [Tor: MRU-A] in 2005. The stock has fallen quite a bit this past year from a high of $32.86 to the recent price of $13.64. The company has a market cap of ~$650M, is trading at a P/E of 13.6 and does not pay a dividend. 

Value investors want to buy good companies at cheap prices. This can mean different things to different value investors. For the prominent value investor Charles Brandes, a value company is one that hasn't had operating losses in at least the past 5 years, is trading at less than its book value and has as much or more equity than debt on the balance sheet. Let's review the record for GAP according to Brandes' criteria (for a closer look at more of Brandes' criteria, I wrote about it here).

Reading through some 2005 annual reports I came across the company Trimin Capital Corp. The company is a management company that makes investments in operating businesses and strives to bring shareholder value through its corporate management and by identifying strong operating businesses and management for investment. The price of the stock in April 2006 was $2.60/sh and it had a market cap of $41.6M. I chose the price in April 2006 to allow a few months for the December 2005 annual report to be readily available in public hands.

The company has a very easy to understand balance sheet and has the least amount of liabilities I have ever come across in an annual report. The only reported liability item is the combined line item of accounts payable and accrued liabilities! The significant assets and liabilities (there is no off-balance sheet operating lease) from the 2005 annual report are as follows:
If you include the impact of outstanding stock options (I used the Black Scholes method) the net asset value per share drops a bit to $3.25/sh. Long term investments is a significant portion of the valuation and requires some analysis. Looking through the notes to financial statements reveals that the long term investment of $22.23M is made up primarily of Trimin's proportionate share of three operating companies, namely, Snack Alliance, TravelCLICK and IPC. The notes regarding long term investments seem clear and straightforward.

Contrarian value investors following methods prescribed by David Dreman in his book "The New Contrarian Investment Strategy" (book review notes here) might be tempted today to take a closer look at some U.S. banks. Dreman doesn't believe in market timing but he does believe that market participants are prone to making systematic errors in judgment due to inherent biases present in human behaviour. Essentially, when times are bad for the market, a sector or individual stocks, market participants have the tendency to be overly pessimistic and price in a perpetually bad scenario. Buying good quality companies with lower than average P/E ratios and higher than average dividend yields form the core of Dreman's contrarian strategy.

One problem with investing in the best banks is that it's extremely hard to know which ones they are! Managers of banks haven't been able to clearly identify all of the exposures and risks, so it's unlikely as individual investors that we will fare much better. In these type of circumstances, where superior knowledge of a company is not possible, it's better to spread risks out by buying a basket of sector stocks either individually or through a vehicle such as an ETF. This is a similar strategy as was advocated in the pharmaceutical article posted here.

Hart Stores Inc. (HSRSF.PK) is a department store retailer operating 80 stores in primarily Eastern Canada. This is a family run business with the Hart family controlling 56.7% of the outstanding common shares.

This company caught my attention for several reasons. First, the price to book value on the stock is around 0.60. Secondly, the price to earnings is only 7.7 times. Thirdly, the company is earning a pretty decent return on its invested capital calculated to be approximately 10%. The company is a small cap stock with a market capitalization of $28.56M. As we mentioned here, small cap stocks often are not as heavily followed as large cap stocks and for this reason can be priced inefficiently in the market.

I showed here that Craftmade International Inc. (CRFT) seemed interesting to value further according to some preliminary screening tests. If a company looks undervalued, the next step could be to value the earnings power and assets of the company. Valuing these components properly requires a deeper look at the business, the industry and the management to better understand and reflect the risks of the business.

There are a few things about Craftmade which make investing in the stock fairly risky. First, the company is heavily reliant on sales from Lowe's.

Craftmade International Inc.(Nasdaq: CRFT) manufactures and sells various home furnishings products, both indoor and outdoor. Some of the types of products they produce for inside homes include ceiling fans, door chimes, lighting kits, clocks and weather gauges. They sell product through major retailer chains and wholesalers.

CRFT is a small cap stock with a market cap of $28.2 million. As explained here, small cap companies have more chance of the stock price being inefficient compared to prices of large cap companies. The stock is trading with a P/E of 7.4 and a P/B of 0.77. The stock has a 52 week high price of $17.11 and a current stock price of $4.95. That's a 71% price drop from its 52 week high! The company raised its dividend payout to 12 cents/quarter on Sep 2005, which based on the current stock price, yields 9.7%.

In our new "Brand Product Company" series, we investigate companies with good brand recognition products and search for current value plays.

Newell Rubbermaid (NYSE: NWL) is a manufacturer and marketer of quite an assortment of consumer brand name products (check them out!). The company works on a growth by acquisition strategy and they have acquired some impressive brands to date. Some of the brand name products you might recognize from this company include Rubbermaid, Waterman, Sharpie, Rolodex and Irwin, to name a just a few.

Ceradyne (CRDN) is a manufacturer of advanced ceramic products. One of its major products is ceramic body armor of which the US government has been a major customer.

This company has undergone some amazing revenue growth. In the period 1998 to 2002, the company had compounded annual growth rates [CAGR] for revenues of 24% and during 2003 to 2007 the CAGR for revenues was 65%! This is impressive growth. One major factor for this revenue growth has been the equipping of troops in Iraq using Ceradyne's ceramic body armor.

One of our readers asked about my thoughts on Trident Microsystems (Nasdaq: TRID). Trident is an electronics company that designs and manufactures integrated circuits for different digital media products such as digital television and liquid crystal displays.

I have looked at several electronics companies in the past and I have to say, the profit margins have been razor thin. Trident seems to be made from the same stuff, as their operating earnings over the past 7 years do not paint tranquil picture. During the past 7 years, Trident has had 4 years of negative operating earnings and 3 years where they had positive operating earnings. Their average operating margins over the last 7 years are negative and imply that if this trend continues they will lose value for shareholders. With the majority of their revenues coming from just 2 customers, I would classify their business model as very risky.

McGraw Hill-Ryerson primarily publishes and distributes educational products including conventional printed textbooks and digital media products. This company is a subsidiary of the McGraw Hill Companies (MHP), incorporated for operation in Canada. You most likely have used one of its products since the company focuses on education and covers the elementary and secondary schools, colleges and universities and professional programs. It has the full spectrum of education covered and has dominated the educational market for many years.

Sounds kind of boring doesn't it? Well that's a start! Finding good quality, boring companies at a significant discount to its intrinsic value is highly recommended by Warren Buffet, the world's most renowned investor. So far, we have established boring, but does this company classify as good quality?

TAT Technologies Ltd (Nasdaq:TATTF) is an Israeli-incorporated company that manufactures, sells and services a broad range of heat transfer components that are used in both commercial and military aircraft internationally. The company is operating in the small cap aerospace and defense sector and as indicated here, is currently trading at a heavy price discount to book value of 56%.

When looking at P/B ratios as value indicators, it's important to follow up the analysis by actually looking at the quality of the assets on the balance sheet. It's also prudent to understand the earnings power of the company to determine if future heavy operating losses are going to deteriorate the balance sheet significantly. For TAT Technologies, I analyzed the company assets and took a very conservative view by considering their liquidation asset value to establish a value floor for the stock.

As I rationalized here, there are currently some beaten up stocks in the small cap aerospace and defense sector. I argued that the sharp price drops and low price to book ratios (P/B) make some of those stocks appear to be undervalued.

Stocks are getting pummeled left right and center in this market, and the aerospace and defense sector is no exception. Table 1 shows significant downside movement from the 52 weeks highs for a few ETFs and market index in this specialized sector.

Table1: % Price drop from the 52 week highs in the Aerospace and Defense sector

My question is, how do we find value with individual stocks in this sector? In my opinion, a cheap stock equates to one that is trading at a price below its intrinsic value. One way to find those companies is to start looking for stocks that have been oversold, are currently out of favor with the market or are just generally being overlooked. Essentially, we want to look at stocks that are not behaving price efficient and as discussed here, its reasonable to start looking at small cap stocks. Table 2 shows what has happened to some of the small cap companies in the aerospace and defense sector.

I have calculated the fair and present value of Aldila’s (ALDA) earnings power to be worth approximately $4.90 per share. I assumed as part of this calculation that Aldila will continue as a going concern. Determining the earnings power value involved calculating the equity holder free cash flows. To be clear, the earnings power value calculation has nothing to do with balance sheet asset values of the company.

One step I took in calculating the earnings power value was to investigate the average operating margin (operating earnings / sales) for the company during the period between 1997 and 2007. It’s important to take a full business cycle in calculating average operating margins because any given year could produce uncommon financial results. For example, during this 10 year period, the highest operating margins occurred in 2004 and 2005 and the lowest margins occurred in 1999, 2001 and 2002. The highest operating margin years over this period coincided with Aldila’s most successful product launch to date with their “NV” line of golf shafts. While shareholders can be hopeful for a repeat of the “NV” shaft success with the recently launched “VooDoo” shafts, for valuation purposes, you will want to use values that you feel reasonably sure will be sustainable in the future. I don’t feel reasonably sure that Aldila will duplicate the success of 2004 and 2005 on an annual basis, but I feel much more confident that they could reproduce the average results obtained during the entire 10 year period.

Aldila (Nasdaq: ALDA), a designer and manufacturer of graphite golf shafts, is showing promising signs of being a value investment according to some basic measures of value.

Aldila's stock is trading with a trailing price to earnings ratio of less than 2.5, a price to book of less than 1 and pays a quarterly dividend of 15 cents, giving it a lofty dividend yield of around 11% based on the current stock price.

I decided to go for a bike ride out in the country this afternoon since I knew that I would be getting an extra dose of calories during dinner at my mother in-law's later this evening. I set off enthusiastically after doing the requisite research with Google maps to ensure that my planned route actually had roads to travel on. As I turned the pedals on my mountain bike I kept my brain active by establishing parallels between two of my favourite activities, bicycle riding and value-investing.

Cycling away from the city towards the country had the pleasant effect of taking me away from automobile traffic. This distinctly contrarian action allowed me to take more than my fair share of the road, as there were absolutely no cars following me once I had gone around 5 km out of the city limits. Similar to my observation of the benefits of low traffic on country roads, if you invest in sound companies that are not popular or are currently out of favor, you have an opportunity to obtain more shares for your dollars then when a stock is popular. Combined with an informed understanding of a company’s intrinsic value, the industry it competes in and any competitive advantages that it might possess, I believe you can obtain excellent investing results as other great value investors have done before us.