SA Interview: Unique Deep Value Investing With Value Investment Principals
Summary
- Value Investment Principals has a 12-year track record focusing on unique deep value and under-covered stocks.
- How they find under-covered stocks, their long track record of outperformance and traits of an ideal deep value idea are topics discussed.
- Value Investment Principals shares a long thesis on Movado and Bassett Furniture Industries.
Feature interview
Value Investment Principals has a 12-year track record focusing on unique deep value and under-covered stocks. Our CEO has 30 years of experience in the investment research, asset management, and HF industries, with all our analysts being MBA-qualified. Their research team is led by Milan Mehta. We discussed how a high net cash balance can act as a catalyst, how to incorporate technical analysis into the investment decision making process and what they look for in high dividend stocks.
Seeking Alpha: Walk us through your investment decision making process. What area of the market do you focus on and what strategies do you employ?
Value Investment Principals: We focus on value stocks that are under-covered and overlooked by the Street. Our investment approach gravitates towards companies that offer favorable risk-reward, and we search for stocks that have a value chart which are on the verge of bottoming out and forming a "U-shaped" curve. We search for companies that exhibit consistent growth and have been historically growing over long periods of time. This creates confidence amongst investors on companies' ability to outperform and hedge against cyclicality in the market. A combination of "deep value" multiples, strong growth prospects, high dividends, and clear upcoming catalysts to help unlock value - we believe this is an intuitively attractive combination for all investors. We generally are sector-agnostic and like to take our focus to a broad range of sectors.
We employ financial modelling and 5-year forecasts for all of our companies that we cover. Our models have rigorous ratio analysis, and we also use DCFs to validate our price targets. We have a long track record of outperformance and providing research to some of the largest Mutual Funds and Hedge Funds [Fidelity, Janus, Putnam and Elliott] in the world, so the quality of the work is really "institutional quality".
SA: What type of reader should follow your work?
Value Investment Principals: If you are searching for your typical Amazon or Tesla, we are not your analysts. We like to look where traditional analysts don't. We like to look at mid-cap stocks that are averaging less than $1 billion in market cap and have fewer analyst coverage. Growth stocks offer you a greater margin of safety, and are heavily covered by the Street, but less chance for greater reward. The small and mid-cap stocks that we like to have in our portfolio offer greater returns over a shorter period of time. Granted, there is an element of risk involved, but we feel that the rewards far outweigh it. And that's where we as analysts come in.
Furthermore, we seek investors who express interest in stocks that showcase high growth in earnings and robust net cash positions. We believe a high net cash position, with minimal to no debt and valued against the market cap, makes a company very attractive. With high net cash coupled with strong ongoing FCF, a company can resort to paying higher dividends or a special dividend, not to mention accretive acquisitions. We also search for dividend stocks, which are always a priority in our screens. Companies with the above mentioned traits have a tendency to be underfollowed and overlooked by traditional sell-side analysts, and this is why they represent an attractive opportunity to reap greater returns.
SA: To follow up, how do you find under-covered stocks in the first place, especially as your typical ideas have zero or limited analyst coverage? What does your idea gen process look like?
Value Investment Principals: First, we do a lot of screening. We use Bloomberg Terminals, which we do agree has a hefty price tag, and that is part of our unique offering. Hardly any retail investors, or even Seeking Alpha publishers, have Bloomberg Terminals. We, as a firm, have 30 years' experience screening on Bloomberg, which has by far the most rigorous database of information, which leads to superior results and performance for us. Our readers can benefit from our expertise and resources. We screen for unique and underfollowed companies, high dividends, deep value, catalysts and positive earnings surprise, etc.
Second, we try to look for macro and secular trends and identify industries and stocks that will benefit from them. For instance, furniture stocks which we have heavily covered [such as our Bassett note, Hooker Furniture note, and Flexsteel note], have been a direct beneficiary of the housing market boom which has taken over the country. We recognized macro trends of people moving to the suburbs and buying more houses during the pandemic and we identified an entire industry, a.k.a. furniture stocks, that would hugely benefit as people would move into their new homes and spend on furniture.
SA: What are traits of an ideal deep value idea? How do you tell if it's a value and not a value trap? Can you discuss the importance of catalysts to unlock value?
Value Investment Principals: The ideal deep value idea can be narrowed to a few key metrics that make for an attractive valuation. These metrics also act as catalysts, and we will demonstrate by telling you some of these metrics that we like to identify and the stock ideas that associate best with them. Most of our ideas have low P/E multiples, such as Movado Group, a watchmaking company, which has a low ex-cash P/E [since it has excess net cash of $8.60 per share, or 30% of the market cap] of 6.5x. Another low P/E company is back-to-office furniture maker Kimball which has a low 9.1x P/E and looks attractive to buy on a recovery outlook going into this fiscal year 2021.
We also generally like to look for companies with higher dividends such as DHIL which has had an 8% dividend [having paid 10 Special Dividends in the last 10 years], and Spark Energy which has had a 7% dividend. Both these companies have high cash, with DHIL having 41% net cash and Spark Energy having a 19% FCF Yield. We also like to look for companies that have had hugely accretive acquisitions. Rocky Brands recently acquired Honeywell Footwear, which was immediately gross margin and EPS accretive, the stock having gone up 120% since our Initial Recommendation. Finally, we like to look for earnings surprise. Bassett recently had a huge positive earnings surprise for its 1Q, beating analyst consensus by a huge 60%.
To sum up, as analysts we seek out companies with low P/Es, high net cash and FCF yields, high dividends, numerous clearly identified catalyst, and earning surprise potential.
SA: To follow up, can you discuss how a high net cash balance can act as a catalyst? How do you incorporate this into your valuation and price targets?
Value Investment Principals: High net cash allows a company greater flexibility to maneuver itself through difficult financial situations by allowing a cushion of safety. Companies with cash-rich positions create expansion possibilities and the option to return capital to shareholders. Greater net cash can lead to accretive acquisitions, expansion by CapEx, declaration of special dividends or an increase in the dividend. Companies that have very high net cash on the balance sheet become good acquisition targets because external bidders feel like they are getting the company for a bargain along with the underlying business. Net-net a company that is in a cash-rich position is seen as rewarding.
One of our ideas, Global Cord Blood Corporation (CO) is a perfect example of a company exhibiting extraordinarily high amounts of net cash because of its style of doing business. The company has 156% net cash against its entire market cap which has led to a takeover bid recently in March 2021. This is on the premise that you are getting the underlying business for free with the acquisition bid.
Another solid idea Movado Group, a watchmaking company, has 30% net cash. This company would be an attractive choice for a takeover if it didn't have high insider ownership, given a consolidating industry in fashion brands. However, unlike the previous Cord Blood Corp, it has used its cash to increase its dividend by 100% which only represents a 25% payout and administer a 5% buyback program. There is room to double the dividend further with a payout increase to 50%, which is a likely move from a company standpoint given its high net cash. Therefore, net cash, as seen from these two examples, is a very important valuation point.
SA: How do you incorporate technical analysis into your investment decision making process? What are traits of an attractive stock chart?
Value Investment Principals: We look for value charts in these types of stocks, so we are able to get in just when the stock is forming that "U-shaped" recovery curve. Commonly referred to by some to be an inflection point, this turnaround in the pricing chart will yield the most robust rewards for investors. This is what we actively search for when we are trying to clock in the maximum returns. Additionally, from a pricing standpoint, we look for companies that have minimal downside risk, protecting our investors from potential losses.
SA: You also focus on stocks with high dividend yields - what do you look for in these types of ideas? What are red flags that income investors should look out for? Can you give any examples?
Value Investment Principals: When we look at stocks with high dividend yields, we look for companies with solid fundamentals and a great track record in trailing earnings growth. We also look for high net cash and good FCF yield so that the dividend for these stocks is sustainable. We don't want to end up with companies that offer high dividends to lure investors in but concurrently can't sustain it as a result of poor valuations and fundamentals. For example, DHIL, one of our stocks that we cover on SA and a stock that has absolutely zero coverage, has 41% net cash and an impressive dividend yield.
A good example of a dividend value trap would be Geo Group (GEO) where the dividend kept on rising [15% and above yields], but the stock price fell over time as a result of its poor fundamentals. Just check the Geo stock price a few days back when it slashed its dividend - it's like a falling knife.
SA: A recurring question in this interview series is about the mispricings created by the coronavirus and its short and long-term impact - can you weigh in on this?
Value Investment Principals: With small-cap markets, such as the Russell 2000, at all-time highs, the "easy money" pandemic opportunities are gone, and it is tougher to find deep value stocks today. Despite this, we are still uncovering tremendous risk-reward situations today, and thus our followers need not chase stocks trading at high multiples with limited upside, but rather still invest in compelling valuations with 100% upside potential - today.
SA: What's one of your highest conviction ideas right now?
Value Investment Principals: Our highest conviction, and also most recent, idea right now is Movado Group. This company is a leader in its domain as a manufacturer and distributor of watches. The company has $8.60 net cash per share, which represents 30% of the market cap, and has an ex-cash P/E of 6.5x. The stock rallied 30% on its latest encouraging quarter results just one week after our recommendation, and we expect on recovery 100% upside. This is a "unlock-and-recovery" trade with a value chart that is ripe for the picking. The company has administered a 5% buyback program and has also increased its dividend by 100% post their encouraging quarterly results.
Lots of positive things are happening at Movado Group which has a 60-40 segmentation with their licensed watch brands segment taking up a bulk of sales. This gives us more confidence as there were some concerns that owned brands, that were 40% of bulk sales, were losing taste amongst customers. But this gives us a buffer of safety and confidence in this stock. Movado Group has high net cash to add more brands to its already attractive watches portfolio, and we are confident that this stock has a lot of good prospects in store for its growth [which has been consistent over the last decade] to yield investors 100% upside.
We are also liking the furniture sector right now. Bassett looks very encouraging from an investing standpoint and is a beneficiary of the surging housing market that has blanketed the US. The company is a deep value candidate with an ex-cash P/E of 11x on a steady-state FY 2022, coupled with 26% net cash [with no debt] and 11% FCF Yield. Bassett also has a record backlog, giving the company legs to outperform the market once orders are fulfilled on a recovery outlook. The chart is an attractive one, still having not reached it 5-year highs as of yet - allowing for greater returns in the medium-term.
In general investors and even Street analysts are totally ignoring huge net cash positions in their P/E valuations - as reported EPS has virtually zero interest income due to very low global interest rates. Thus for both Bassett and Movado Group we have added back net cash for more robust and accurate price targets. Another mispricing, or opportunity, is that most of these companies are underfollowed in the market.
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Thanks to Value Investment Principals for the interview.
Value Investment Principals is long BSET, MOV, HOFT, FLXS, CO.
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