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Lexmark: The Falling Knife Worth Catching

Saj Karsan profile picture
Saj Karsan

Six months ago, shares of Lexmark (LXK) fell from $48 to $38 in a single day, following the company's earnings release. The company was subsequently discussed on this site, and though the stock did seem undervalued, there remained a number of risks on the horizon. Last week, however, the stock fell big once again, this time from $38 to $32, as the company missed expectations and guided lower for the rest of the year. At this price, there appears to be a large margin of safety to help mitigate this company's operational risks.

Lexmark has a P/E of just 7, despite having more cash than it does debt to the tune of $600 million. Excluding this net cash balance from the company's market cap gives the stock a P/E under 6.

At such a high earnings yield (which is simply the inverse of the P/E ratio, or 17%) one might expect this to be a company in serious trouble. But that's not the case. In fact, though the company does operate in an industry where it needs to constantly innovate to remain competitive, there are some tailwinds on the horizon which should actually help the company's earnings in the long-term.

A few years ago, the company changed its strategic focus. It no longer wanted to be a low-end supplier of printer hardware and supplies. In this market segment, printer manufacturers have low margins as they compete to serve mass-market consumers who are mainly interested in low prices. Lexmark instead invested in printers and products that businesses need to enhance productivity. This transformation appears to be working, as Lexmark is seeing market share gains and revenue and profit growth in its higher-priced products.

But the overhang from the company's slow exit from its lower-margin segment remains. As competitors in this segment have

This article was written by

Saj Karsan profile picture
Saj Karsan founded an investment and research firm that is based on the principles of value investing. He has an MBA from the Richard Ivey School of Business, has completed all three CFA exams, and has an engineering degree from McGill University. Visit his blog, Barel Karsan (http://barelkarsan.com/).

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