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Hidden Value: Universal Security Instruments - Part 2

|Includes: Universal Security Instruments, Inc (UUU)

Continuing on from Part 1, I'm going to take a look at the intrinsic value of Universal and discuss any risk factors.

I've used the adjusted earnings approach recommended in Greenwald's Value Investing to determine the intrinsic value.

I took the the average margin for 2007, 2006 and 2005 and applied it to the Earnings Before Income Tax to be able to adjust the earnings so that they are in line with normal market conditions, i.e. not depressed.

From looking at the "Income as adjusted margin", we can see that Universal has not been able to maintain a reliable margin over the past 5 years and has often mismanaged their cash flow, resulting in either miniscule or negative margins.

This will have a significant effect on the valuation. To determine Universal's intrinsic value, I have used the Earnings Power Value (NYSEARCA:EPV) formula suggested in Greenwald's book:

EPV = Adjusted Earnings x 1/R

R is the cost of capital. I chose 10% as the cost of capital because as a guesstimate, it seemed conservative, considering current low interest rates.

From taking a look at the "Total EPV", which is the value we estimate Universal to be worth, we can see that this stock is not likely to be a worthwhile long term investment as it struggles to maintain any reliable level of value, suggesting poor management and a poor outlook.

However, from looking at the "Market to Book Ratio", it identifies that in the good economic times (2005-2007) the company was priced at least at 2x its book value and that it's a likelihood that if we invest today and hold until we return to more prosperous economic times, we could see a nice return but it would be purely speculation.

For the above reasons, I would not invest in this stock.

For the sake of following through, I'm going to highlight a particular risk factor which would also hold me back from investing.

Risk Factor 

Currently, over 40% of Universal's sales come from one large national retailer, the Home Depot. Any changes in this relationship would significantly affect the future of the company. This on its own would make me uncomfortable but there's also the matter that this retail relationship has in fact changed. The Home Depot will no longer be stocking Universal's products in their stores, apart from at the retailer's contractor desks. They will also be available online.

Unfortunately, I do not have any figures to be able to guess how this might affect the future of Universal's sales but one can only imagine that their reliance and this change will not create a positive outcome.

Again, for all of the reasons above, I will not even be considering Universal as a potential holding within my portfolio.

NOTE: This is just my opinion. I'm not a professional in the financial world. Please conduct your own due diligence in any decisions to purchase, sell, or otherwise trade any stocks.

Disclosure: No Positions