Wednesday, October 1, 2008

Value In Action: Harris Steel

In 2002, markets were depressed. Much like today, bargains could be found for those who scoured the market. It's useful to take a look at undervalued companies from 2002 and see what has happened to them since. Could you have made money on some of these stocks? If so, by applying those same principles today, perhaps one can achieve similar results.

One example from 2002 is Harris Steel, a company that purchases steel and processes it for end-customers. In general, we like to avoid individual companies that produce commodities, since they are subject to unstable and unpredictable prices. In the case of Harris, however, as a buyer and re-seller they are somewhat more protected than a straight steel manufacturer.

In April of 2003, Harris had a share price of $19.25 and a 2002 EPS of $3.66, giving it a trailing P/E of just over 5! Why so low? In addition to being part of a depressed market, Harris' EPS of 2002 had actually fallen from $4.43 in 2001, and as we've seen before and as discussed by Ben Graham, Wall Street perhaps places too strong an emphasis on earnings trends. Earnings aside, let's take a look at three items from Harris' balance sheet ("per share"):

A/R: $16
Inventory: $16
All Liabilities: $11

Basically, Harris' receivables and inventories less its liabilities were more than its share price! That means were you to buy a share of Harris during that period, you would be receiving all its factory equipment, customer relationships, and expertise all for free. Of course, this doesn't constitute a full analysis. One must still read management's discussion and analysis and full financial statements along with its notes to fully grasp whether a company is undervalued.

So what happened? A year later (April '04) the share price was 20% higher at $22.60, and a couple of years after that, Harris got bought out by Nucor at more than twice this level. Can one find such bargains today? Perhaps not so easily in commodities, but there are depressed sectors out there...

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