najdorf

Low P/B Ratio Defense Small Caps

I don't think P/B ratios are particularly useful unless you include some analysis of the make-up of the B. I understand this is a preliminary screen, but you really have to be cautious with P/B and I don't think it's even a good screen to start with - better to look at earnings and future expectations.

The reason P/B got a good reputation is that back in the Benjamin Graham heydeys he was able to buy companies that held net cash and high-rated bonds right around their market capitalization (i.e. you were buying the cash and bonds and getting a company that might actually turn a profit in the bargain). The idea was that even if the company couldn't turn a profit, they could at least liquidate and pay off investors.

I don't think these companies are that sort of value pick. If I look at the balance sheet for ARTX, the assets are about half goodwill and intangibles. If the company were earning on that goodwill/intangibles, if those indicated that they had acquired profitable companies and developed useful intellectual property, it would be fine. But they're not earning - earnings have actually been negative. So it seems that their might be a goodwill writedown in the future for ARTX, because you can't really profitably liquidate the goodwill of a company that doesn't turn a profit.

The rest of the assets that are making up the book value are a little better, but inventory is pretty high (almost a quarter worth of revenue), as are recievables (similar magnitude). This suggest a fairly inefficient company. You also have to consider that their property and equipment may be specialized to the particular products they produce, so it may not actually possess its stated book value if it can't be used in a profitable business.

I figure that if ARTX could clean up their inventory and recievables they probably could do a lot better on cash flow for a few quarters, but is the underlying business actually profitable? Can they rely on government contracts flowing to a small and unprofitable company? Tread carefully here - all that book value could fall apart in a hurry. There's a reason the price is so low.