Recently on the Stock Watch segment of the nationally syndicated George Jarkesy radio show Clay Mahaffey and I discussed two specific stocks, Strayer Education (NASDAQ: STRA) and Lorillard (NYSE: LO). The first was significant not so much for the trade itself, which listeners that day realized a nice twenty percent profit if they sold six days later on April 26th. STRA was part of the National Eagle and Angel, Micro Dynamic Portfolio, that employs a strategy of looking for stocks that the market has over reacted to and are undervalued or overlooked. In the case of Strayer we have a stock that the market sold off on some bad news, but ignored the underlying fundamentals. The stock then experienced a rebound over the course of a week and produced around a 20 percent return.
With Lorillard we discussed a company that has utilized debt creatively to effect a rolling recapitalization and stock buyback. This very interesting strategy which Lorillard has deployed is explained by the Chief Analyst of the National Eagles and Angels Association below.
George Jarkesy: If you listen to the George Jarkesy Show, and if you were listening to George Jarkesy Show on April 20, 2012, you would have learned about Strayer Education, because Clay Mahaffey, Chief Analyst of the National Eagles and Angels Association, recommended it $86.00, and I hear that today it closed at $99.00 on great earnings. That's right. They had big earnings; the stock was up 20 percent in a week. Mahaffey and I spoke about it just last week. Clay Mahaffey, is the chief analyst of the National Eagles and Angels. He comes on last week and he's talking about Strayer Education, stock symbol STRA. This week the stock's up 20 percent and it's interesting, because Clay was talking about it regarding a dividend play with growth upside, that growth was almost instant. Joining us now is Clay Mahaffey, the Chief Analyst of National Eagles and Angels.
Clay Mahaffey, CFA: Yeah, George, how are you doing?
George Jarkesy: Well you look like a hero. A lot of our listeners made a lot of money in the last few days on Strayer Education. , you're up 20 percent in less than a week. You were buying it for the dividend, it has a nice dividend, the company has been buying back shares, things were going good, even though they had been off a little bit, I think on the revenues, if my memory serves me correct. You still like the dividend. You thought they were long-term dividend with upside play, and wow, 20 percent returns in a week that's impressive.
Clay Mahaffey, CFA: It just shows you people will over react in a sell off. They were looking at the last quarter of new students registering in the prior quarter was down 20 percent. The stock as you know is down from $250.00 to $86.00. So you just look at it that way and there enrollment has increased so the stock was really beaten down and everybody thinks these students are going to finish their education. Still it's a four-year effort; its one quarter. People were really over reacting over one quarter of enrollment, and projecting like they sky is falling down.
George Jarkesy: This bring up such a good point that you're always making, which is that those over reactions, create buying opportunities as well as, selling opportunities. Selling meaning, you made a lot of money very quick, and it went higher than it was expected to go in a short period of time, and buying opportunities because of the sell off and it ends up getting much cheaper, which is a lot of what you're talking about in what you built in the National Eagle and Angel, Micro-Dynamic Portfolio, correct.
Clay Mahaffey, CFA: Yes, that's part of the strategy, of companies that have been beaten down unfairly, there is typically an overreaction. You just look at the fundamentals, the valuations, and some of the projection as to where the stock should be, and with stocks like Strayer, with it's nice dividend, yielding 4.6%, how low is it going to go?
George Jarkesy: We've heard a lot of good things about Strayer this today, a lot of great response, but what do you have today, that our listeners can make money with?
Clay Mahaffey, CFA . It's was way up today. I was going to talk about it Friday. I think it went to $130.00 today. It's up 3-4 percent. This is another dividend yield story, but it's yielding 4.8 percent today, they basically do a rolling, recapitalization of the company. This is a cigarette manufacturer, primarily, menthol cigarettes. They're famous for Newport, that's their big brand. It's an extremely profitable company. And by rolling recapitalization, they generate $1 billion, per year, in free cash flow. They don't spend practically anything on plant equipment. What they have is good enough. They're just maintaining it to keep it in operation. Regularly, they go out in the market and they can borrow additional funds around $700 million per year, at a 4.7 percent average. So now, they have basically, $2 billion per year to distribute. The way they distribute that cash is based on $1.1 billion buying back their shares and the additional $900 million to get to shareholders to pay dividends so they're leveraging themselves and you say how can they do that? They have such a low debt level and debt coverage ratio -this is a key factor- they can pay the interest and their cash flow to interest is over 10 times. Normally, banks would required a ratio of 2 or 3 to 1, they have a 10 to 1 ratio, so they can keep borrowing this amount of money for years. Another point is that they have been doing this for three years now. They bought back 20 percent of the stock in the last three years. They bought back 10 percent last year alone. So if you extrapolate this forward, I don't think people are going to quit smoking Newport's tomorrow, If they keep buying back 10 percent of the stock per year, in five years this is going to be like a $300 stock.
George Jarkesy: Right, that's fantastic.
Clay Mahaffey, CFA: The denominator is going so low; it's down to 132 million shares. And the buying back of five or 10 million shares per year, with these ratio's, it just keeps going up and up and up.
George Jarkesy: Yeah, they know what they're doing. They're basically, forcing the price of their stock up.
Clay Mahaffey, CFA: Exactly.
George Jarkesy: With the buy back. They're buying it back cheap and they're buying it with cash flow. That's sounds like a great opportunity 4.8 percent wide.
Clay Mahaffey, CFA: George, they're leveraging themselves. Every other company in the world is deleveraging, trying to pay down the debt they took on. This is one of these rare companies that had too little debt, and they're taking on more, because of the market, the rates were available.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours..
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.