Saturday, November 22, 2008

From The Mailbag: Servotronics

Servotronics (SVT) is a designer and manufacturer of advanced electronic control components and cutlery. The control components are mostly provided to the military, while the cutlery products are various kitchen knives marketed for both household and industry use.

SVT has a market cap of just $13 million, so it most certainly flies well under the radar of institutional buyers. As such, this is where one can find the most inefficienly priced securities, and so small investors who do their homework can profit over the long term by buying the ones that trade at large discounts to their instrinsic values.

SVT's cash, accounts receivables, and inventory cover all of its liabilities, with some $8 million to spare. This means you're paying only $5 million ($13 million - $8 million) for its cash generating assets, with little to no risk of liquidity concerns. So how much are these cash generating assets worth? Well in the last four years, the company's net income has averaged just over $2.5 million per year!

From this perspective, the company looks very cheap. However, there is one caveat. Digging into the company's financials reveals that around 50% of the company's revenue comes from the US government, specifically overseas military. Having one customer as such a large percentage of sales represents a very real risk, particularly when there is much uncertainty surrounding the future status of US military operations overseas.

While this may turn out to be a very good stock over the long haul, there are plenty of other opportunities out there in this fearful environment where such risks are not present.

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