The Manual of Ideas'  Instablog

In last month's issue of Downside Protection Report, we discussed investors’ tendency to look for perfection in their investments. We argued that perfection was not achievable, as a perfect business does not come at a perfect price. As investors, we are forced to compromise, weighing the price we pay against the value we get.

The compromises we struck in the March issue appear to have been good ones, at least so far: K Swiss (Nasdaq: KSWS) and Sierra Wireless (Nasdaq: SWIR) are up 19% and 66%, respectively, since we recommended them, while the S&P 500 Index has gained 9%.

In this issue, we highlight two more imperfect candidates—Harvest Natural Resources (NYSE: HNR) and Gravity Co. (Nasdaq: GRVY). Once again, we like the compromises we are making, as it seems Mr. Market is compensating us handsomely for what’s wrong with these companies while extracting hardly any price for what’s right.

In the case of Harvest, investors appear to be focused on the fact that the company’s primary producing assets are in Chavez-ruled Venezuela, while ignoring the fact that 84% of Harvest’s market value is accounted for by cash deposited in domestic banks, with additional value tied up in several high-potential exploration projects outside of Venezuela. We show that the current valuation provides a robust margin of safety, at the same time providing us with enviable upside potential.

The case for Korean online games developer Gravity is even clearer. After repeatedly disappointing investors with operating losses and poor execution on new games, Gravity brought in a new CEO last August. While much work remains to be done, initial results have been positive. The company has restored double-digit revenue growth and turned solidly profitable. The only one not noticing this inflection point seems to be Mr. Market. Gravity still sells for $27 million, or well under five times the apparent operating income run rate. Oh, and did we mention that Gravity has more than $40 million of cash and no debt?

We do caution that Gravity is a microcap stock with low trading volume. As a result, any purchases should be made deliberately and spread out over time. There is no need to overpay—even for a good thing.

Disclosure: Long HNR, long GRVY, no position in SWIR, no position in KSWS.