Tuesday, March 17, 2009

Hammond Powers Up

Less than three months ago, we discussed the margin of safety that appeared to prevail in the price of Hammond Power Solutions (HPS.A). Since then, amidst the doom and gloom in the market, the price of the stock has increased some 25%. The price movements and general characteristics of HPS.A offer a great example of the advantages that small investors have in the stock market.

First of all, Hammond Power is a small cap company. As has been noted several times, prices among small-caps tend to be more inefficient than they are among other issues, as sophisticated analyst teams and institutional investors in this realm are few and far between.

Second, this stock suffers from a lack of liquidity. For day traders and momentum investors, this represents a serious hindrance, and they punish its valuation accordingly. For value investors with a long-term outlook, this offers an excellent opportunity to buy great companies at cheap prices.

The lack of liquidity can sometimes (and it does in the case of HPS.A) lead to wild price swings. For the general finance industry, this symbolizes risk (high beta) and thus leads to further valuation punishment. To value investors, risk has to do with the company's business and financial risk, not with its price swings. Price volatility offers the value investor great opportunities to buy at great prices. As Warren Buffett said when we spoke with him last year, price volatility is the friend - not the enemy - of the value investor.

Small investors have the opportunity to buy great companies at inefficient prices. For those willing to spend the time to uncover these gems, long term returns are abound.

Disclosure: Author has a long position in HPS.A

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