Wednesday, October 8, 2008

From The Mailbag: OMG!!!

That's not the Lord's name I'm taking in vain; the title refers to OM Group (OMG), the largest cobalt refiner in the world. It has a low price to book ratio (the value of which we've discussed here) and a low P/E, warranting a closer look.

The company has been very active in acquiring and divesting businesses, as it re-organizes itself to better take advantage of its core strengths. While this may indeed be in the best interest of the company, it adds some uncertainty from the point of view of investors: we can't rely on past operational data in trying to value this company. So while it may be a great investment, we prefer companies where we can be fairly confident with respect to its profits going forward.

Another factor which reduces certainty for this company is that the price of cobalt (on which OMG is heavily reliant) undergoes significant price fluctuations. As such, the company's profits to a large extent are outside of its control. You could have the best managed company in the business, but if supplies are too expensive and customers switch to substitutes, profitability gets hurt.

Its price to tangible book value is just .66 with low debt levels. Its price to book value is even lower, but we prefer to strip out Goodwill and other intangibles in our book value calculations (it's very difficult to determine whether these are worth anything from the point of view of an investor trying to ensure downside capital protection). Furthermore, the company is diversified across several product lines, which does give it some stability. As such, for someone that understands the industry well and can thus value the assets and to some extent forecast cobalt prices, this may prove to be a decent purchase. For me, I'm afraid it's outside my circle of competence, so I can't justify swinging.

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