Collectors Universe Mints A Dividend Part 1: Coin Grading And The Future Of The Hobby

| About: Collectors Universe, (CLCT)

Summary

Attractive and largely unnoticed high yielding dividend at stake.

Introduction into the importance of coin grading and third party encapsulation.

The future of the numismatic hobby looks promising and at least continued.

Demand for PCGS will come from a number of different sources.

In this article, I want to offer up my experience as a professional numismatist as well as a part-time appraiser of collectibles and related personal property. The average investor may not understand the core business of coin grading, how it has transformed, and where the hobby of coins and collecting in general might be going in the future. A proper understanding may make a more informed investment decision.

Collectors Universe Inc. (NASDAQ:CLCT) is a company that caters to the need for third party grading of not just coins, but a number of other collectibles such as trading cards (your old baseball cards), paper money, comic books, and autographs. The focus here is on PCGS, their coin grading service. The overall market for certification of other collectibles is rather small in comparison and will be analyzed in my next article.

What makes the stock so interesting and compelling for the long-term dividend investor is the compelling dividend at just over 9%, compared to earnings of $7.5 million, on just over $60 million in sales. Nevertheless, that rate is fairly high and such an esoteric and niche business might suggest it is not sustainable in the long run. Does the business have a future? Let's take a look.

Why is third party grading important in this industry?

In the world of coins, grading is a subjective practice, not a science (though we would love it to be). It seeks to use a scale from 1-70 to grade a coin, pioneered by Dr. William Sheldon, a specialist of early American copper coinage and author of the classic Penny Whimsy.

At the top of the scale are coins graded between MS 60-70. They are known as mint state or uncirculated. They exhibit no wear or circulation and are considered the most desirable condition a coin can be in. The scale continues down to About Uncirculated (50-59), Extra Fine (40-49), Very Fine (30-39), and so on all the way down to Poor 1, being a coin circulated to the furthest point, but still identifiable by date and design.

Grading is important because there is actually quite a bit of difficulty in acquiring many coins with higher grades, and especially within a given year or mintmark. This translates to higher prices realized as the majority of collectors and investors buy based on grade.

Imagine owning a coin in MS-63 that is valued at $300. Not bad. Now imagine that coin in MS-65 that is worth $3,000. This trend exists in hundreds of different examples throughout the scale in which a difference of just one or two numbers on the scale can mean several thousand dollars difference in the price. Advanced collectors often know the difference between a 63 and a 65, but most casual collectors will have disagreement. Most dealers will want to reassure their customers of the grade.

Thus a third party grading service is extremely helpful in assisting buyers and sellers as to the accuracy of a grade. That said, there are many prominent numismatists who will disagree with the grade assigned by PCGS. For the casual population though as well as investors, PCGS and other third party grading services are vital to making a safe purchase or sale.

What is the future of the coin hobby?

The future of the hobby of collecting and the buying/selling associated with it is difficult to predict. Go to any given coin show, trading card show, stamp show, etc. and you will find that the medium demographic is middle aged to retired white males. The hobby has a notoriously difficult time attracting youth and minorities. Nevertheless, the major organizations such as the American Numismatic Association are making wonderful inroads at introducing the hobby to everyone, including a new generation.

That said, there is some potential for upside. The popularity of television shows such as American Pickers and Pawn Stars has pushed some youth and fun in what has traditionally been the hobby of baby boomers and those introverts who prefer a quiet discipline. Coupled with the perception of mostly depressing results from traditional investments, more Americans are taking an interest in valuable collectibles.

Further, coin collecting was once known as the hobby of kings and is now commonly referred to as the king of hobbies. The 50 State Quarter Program may have planted the seeds for subsequent generations to come back to the hobby when they near retirement. It is accessible.

After all, numismatics has survived the Fall of Rome, The Dark Ages, World Wars One and Two, The Great Depression, and a number of other catastrophes threatening its existence. All declarations of its demise have been met with a new generation interested in taking over. Other collectibles cannot claim this distinction.

Finally, professional coin dealers have seen a spike of interest from numismatists as well as stamp collectors from India and China as the widening middle class looks to add alternative assets to its portfolio, namely issues of their own country. PCGS is primed to take advantage of this market as it continues to develop and mature in Asia.

Where will continued submissions come from?

In order to maintain that high dividend, the bulk of Collectors Universe business will have to remain healthy and growing: coin submissions. I have seen the question asked: "aren't all of the old coins eventually going to be submitted?" The reality couldn't be further from the truth.

Over the next 20 years as baby boomers pass on and their estates are handed down, more and more coins that haven't seen the light of day for decades will be revealed. In most cases, the estate will be encouraged to seek third-party authentication and grading. Collectors Universe will be eagerly waiting as they are often referred to as the top grading service.

Further caches of coins and hoards are discovered with regular frequency. The Saddle Ridge find made headlines for weeks, but many smaller finds of gold and silver coins appear almost daily on abandoned properties, ghost towns, and by relic hunters. Although it's a significantly less number of submissions, it is a regular part of business.

Remember those people filling up 50 State Quarter folders? The United States Mint, in addition to a number of other mints throughout the world continue to innovate with new commemorative coins, enabling holographs, esoteric shapes for coins, rare earth metals, and all sorts of other gimmicks. Mints regularly produce popular bullion programs in platinum, gold, and silver.

There is a joke among numismatists about those whom have aspirations to become professional graders at places like PCGS. They better be careful what they wish for; if they get that job, they will be staring at the same American Silver Eagle bullion coins every day.

Finally, there is the issue of resubmitting. If the dealer in the example above received a coin from PCGS graded in MS63 and thought it deserved better, he will very often crack it out of the slab and resubmit it looking for a higher grade. The process can go on several times as long as there is a financial gain to be had. The same is true for taking slabs from other companies and submitting them hoping for a better grade.

Conclusion

I believe the future for coins is bright and that Collectors Universe stands to continue its dominance as a third-party grading service. Whether the demand and hopeful growth in the coin industry is enough to maintain such a dividend is for you to decide.

There is another element to this story that is worth looking at. Assuming the future of coin collecting is bright (it is still a large assumption), one must look at Collectors Universe compared to their competitors, namely the privately owned NGC. PCGS has a strong hand in the industry, but NGC is often a close second. In most auction houses, the two are synonymous with rare coins. Some coins, namely tokens, medals, and ancient examples, put NGC as the front runner. Being the official grading service of the ANA also gives NGC a long-term advantage.

In my next article, I will look at competition, not just in the coin segment from NGC, but paper money, stamps, autographs, and trading cards. Competition may have an impact on the ability to pay that dividend moving forward.

From there I want to look at the other coin-related assets that Collectors Universe is managing such as Coinflation.com and Collectors.com and judge whether those business models are being implemented correctly.

Before that, take a look at this well-written article from Corey Chappell, which predicts a decidedly pessimistic view on the immediate future of PCGS and makes several compelling points for problems with the dividend. As well, visit my rare coin appraisal website and corresponding blog for information on numismatics. I would be happy to entertain questions regarding this company from the perspective of a numismatist.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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