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Tim Welland
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Tim is a graduate of the University of Michigan, with a degree in economics. He works in the litigation consulting industry and has been investing for a few years. Tim is a value investor, but likes to work in special situations as well.
My blog:
Parkside Value Investing
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  • The Proxy Statement, More Important than You Think
    In evaluating a company, it can be difficult to get a read on management.  Are they running this company in an upstanding and honest way?  Are the directors and officers paid commensurate with their contributions to the firm?

    Here's where the proxy statement comes in.  Though it is obviously not a direct evaluation of management, it can help you "read between the lines" to form an opinion on management, and whether or not they care about you.  It also contains a few other great nuggets of information that you might find useful.  I'll run through those as well, don't worry.

    Here are eight things to look for in the proxy statement:

    1) Who owns the company.  Firms are required to disclose director and officer ownership, as well as 5%+ owners of their stock.  Many people (including myself) think that having insiders with a considerable ownership stake in the company is a good thing.  There is a limit to this in my mind, however, because I don't want to be an owner in a company that is controlled by an insider or founder.  Too risky.  Some companies require that directors and/or officers hold a certain amount of stock.  I like these companies.

    2) Who the directors are.  Each director will have a short bio in the proxy.  High level officers will as well.  I like to see that the directors and officers have been with this company for a while and that they have been promoting from within.  This shows that the firm has a good development system and recognizes internal talent, giving employees the incentive to work hard.

    3) Director independence.  I like to see a majority of independent directors, especially on the committees.  This gives me comfort that I'm not looking at the next Adelphia.  Companies that are controlled by a person or group are not required to have a majority of independent directors; I won't touch these companies.

    4) Who is on the committees.  As mentioned, I want these to be almost entirely independent.  Hopefully the outsider directors will better monitor the officers.  The charters of these committees will also be available; I have found these useful on occasion.

    5) The Compensation Committee.  If the CEO is on this, tread carefully - I would probably toss this in the garbage can.

    6) Compensation.  How much are these guys making?  Does it seem reasonable?  Use your best judgment.  The proxy will also tell you compensation guidelines; it is from this that you can judge the ways in which management is evaluated and can decide whether or not you agree with this.

    7) Any other perks afforded the directors and officers.  Golden parachutes, tax gross ups, use of corporate jets, gym memberships, etc.  Are the executive perks reasonable?  Or does it seem like management is milking this company a little too much?

    8) Related party transactions.  This is going to be especially important for smaller and/or newly public companies.  See if there are any transactions and what sort they are.  Do they seem fishy?  Are they a significant amount of money?  Small related party transactions don't bother me, but when the CEO has some small company that is being paid a "management fee" I start wanting to know more.  If you have any concerns, don't hesitate to move on.

    In short, there are a many things in the proxy that can help you decide whether a given company is your next investment, or another one for the trash heap.

    I recommend skimming the proxy (search for the DEF 14A on EDGAR) for these particular things, and anything else that sounds important.  You might be surprised what you find!


    Disclosure: No positions.
    Jun 10 1:50 AM | Link | Comment!
  • American Eagle (AEO) looks like a good "heads I win, tails I don't lose much" play
     Background:
    AEO sells men's and women's clothing from their AE brand and aerie brand stores.  They also sell children's clothing through their 77kids stores.  AE is an established brand, aerie and 77kids appear to have growth potential.
     
    Stats (as of June 6, 2010):
    Market Cap: 2.54B
    Price: $12.14
    P/E: 16.16
    P/S: 0.9 (more on this later)
    Yield: 3.29%
     
    Thesis:
    AEO has taken a beating over the last few days, due mostly to a "poor" guidance issuance.  AEO has been hit, just as over stocks have, by the economy over the last two years, and it's stock has fallen along with it.  However, sales have held up relatively well, and the company remains in great financial condition.  The balance sheet is clean, and cash flows continue to be strong.  In fact, AEO has approximately $1.50 per share of net cash/short term investments/long term investments.  Management has cut back on expansion and CapEx as sales have been hurt.  EPS has fallen in half since 2007.  In addition, the company announced the closure of its MARTIN+OSA brand for older shoppers.  This is expected to cost the company up to $40 million over the next few months.  M+O was losing about $20 million per year for AEO.
     
    For me, AEO represents a very compelling investment opportunity.  AEO is in sound financial condition, and stands to benefit from any reversal in economic fortunes.  In my opinion, there are a number of metrics by which AEO is undervalued:
     
    1.  Subtracting net cash, AEO trades at a P/S of approximately .75.  Any increase in sales would obviously increase the market cap, and AEO has traded at a P/S ratio maximum of 2.8 in recent years.  Even a more conservative ratio of 1.5 would double my money.
     
    2.  By my calculations, normalized EPS last year was approximately .20 per share higher than reported.  GAAP EPS included approximately $40 million in charges that were either one time or are in the process of being dealt with: a one time write down of some assets owned by M+O, and M+O's yearly loss.  After taxes (I calculate this using AEO's last year tax rate of 27% and a more realistice 40%), this represents 11 to 13 cents in incremental income, leading to a potential valuation of $14.95 to $15.35.  In summary, merely normalizing earnings gives you a 25% potential upside.
     
    3.  Lastly, I firmly believe in AEO's products and business, and their ability to turn things around.  A key metric, net sales per avg selling sq ft has fallen from $642 in FY2007 to $519 in FY2010.  If you assume that this can come back up to $575-600, EPS (assuming a 10% net margin, lower than the historical 13%) would increase to $1.41-$1.47.  If P/E stays constant, the stock price could hit $23.50!  If P/E were to decline to 10 (which seems completely unrealistic), the stock price would still be $14.70, a small gain.  AEO's close competitor Abercrombie and Fitch (NYSE:ANF) trades at a P/E of 34.  I'll let you salivate over that math.
     
    In sum, AEO looks incredibly attractive and I think this is a classic case of the street overreacting to temporary bad news.  AEO is still an attractive business and is very undervalued at current prices, especially when you factor in that $1.50 of your purchase price is going to buy pure cash (and some illiquid investments that I will acknowledge could potentially be removed from this calculation).  And hey, if AEO doesn't move any time soon, I'll be happy collecting my nice 3% dividend for the time being.

    A few other points that I should mention on why I like AEO (more generally):
    1. AEO has a large deferred tax asset, a sign that earnings might increase in the near term (this basically means that AEO is being more conservative in their GAAP reporting than their IRS reporting, something that is a harbinger for higher future net income).
    2. Directors and Officers collectively hold 10% of the company, a nice sign that their incentives are aligned with the shareholders (as they are, themselves, shareholders).
    3. Though they haven't purchased shares recently, AEO's board has authorized the repurchase of up to 20% of the firms shares.


    Disclosure: Long AEO.
    Jun 09 12:31 AM | Link | Comment!
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