Monday, April 13, 2009

For Value Investors, Smaller Is Better

Value investors are always looking for inefficiently priced stocks. Such stocks are often found among smaller cap issues, since these securities are not worth the time and the effort of analysts and institutions catering to billion dollar funds. Empirical evidence also supports the fact that small caps have the potential for greater returns, but outstanding returns only come to those willing to seek out value among the thousands of issues available.

Consider a stock such as Limco-Piedmont (LIMC), a maintenance, repair and parts and services supplier to the aviation industry. Limco trades for $30 million in the market, but consider the following balance sheet items:

Cash + Securities: $33 million
Accounts Receivable: $12 million
Inventory: $19 million
Total Liabilities: $10 million

With those balance sheet numbers, you would expect that the company is losing money hand over fist to have a market cap of just $30 million. But this is not the case. The company has contracts in place with several customers, including Fokker, KLM, Lufthansa, Boeing and Bombardier, resulting in a 4th quarter profit along with net income for 2008 of $2.7 million.

As an added incentive for investors, Limco is also the subject of a takeover offer which is 20% higher than its current price. A group of Limco's investors are pushing for a higher takeover price, but even if the deal falls through, buyers at this price appear to be purchasing at a discount based on Limco's cash position.

Rest assured, you will not find such a situation among well-followed large-cap stocks. It is near impossible to find a large company trading at a discount to its cash on hand, and if one can be found in such a state, you can rest assured it is because its debt load and negative earnings have the company in dire straights with doubts as to its future. Limco's debt level: $0.

Disclosure: None


Anonymous said...

I agree on your article. But didnt Graham prefer large companies instead of small ones? Are there any studies where you can find evidence that you get better return from small value companies vs big value companies?

Anonymous said...

Have you looked at the acquirer of LIMC, which is TATTF?

33.68M mkt cap
45.21M Cash
5.34M Debt
11.61 BV/Sh

positive net income and cash from operations, but higher cap ex recently.

Ravi Nagarajan said...

Do you have a link to a news report on the proposed takeover offer, or is this in the 10K? From a quick look at the numbers, this looks like a classic net-net - only problem, like many other net-nets is very low volume.

I'm keeping my net-nets close to the vest myself due to low volume. Very exciting to see these opportunities - rare to be able to apply Graham's approach!

Ravi Nagarajan said...

Looks like they are paying in shares:

Saj Karsan said...

Hi Anon1,

Yes Graham did find that during recessions that, in the aggregate, large companies were less likely to go bankrupt. But by examining individual securities yourself (i.e. not looking at the aggregate) you can separate the unsafe ones from the safe ones. E.g. a small company with lots of cash and no debt is more safe than a large GM, even tho bankruptcies may be higher among small companies than large.

Hi Anon2,

Yes we've discussed TATTF here.

widemoatinvesting said...

TAT itself is quite undervalued, but what chances do you place on this going through? On its face, you would figure that an acquirer has to pay at least book value for a profitable company. But would TAT up the offer to a 1 for 1 share exchange? Probably not with their own stock so far below book value.

I figure that the chances of this closing are less than 50% at this price. Though TAT is the majority shareholder, class action lawsuits will be filed on behalf of the minority.

Saj Karsan said...

Hi Wide,

The point is, even if the transaction does not go through, you are still getting an attractive price on LIMC.

widemoatinvesting said...

I'm with you on the attractive price, but I am curious how others estimate the expected value of the purchase.

If the buyout likelihood is less than 50%, then the potential drop should be factored in. The 52 week low is $1.77, but in this case, a failed buyout may actually raise the price.

Anonymous said...

Has anyone tried this yet?

benjamingrahamcracker said...
This comment has been removed by the author.
benjamingrahamcracker said...

@ Anonymous // April 21, 2009 1:16 PM
"Has anyone tried this yet?"

No. Value investors don't do currency trading. Sorry.

benjamingrahamcracker said...

A valuable piece of information everyone is forgetting. Since this is an all stock transaction, that means that after the transaction occurs TATTF's outstanding shares will be approximately 13.15 Million share rather than the current 6.55 million shares. That will greatly dilute the current price. If the transaction happened today for example, TATTF will give 1 issue of stock for every 2 you hold in LIMC. LIMC's outstanding shares are currently 13.20 Million. 13.20 / 2 = 6.60 Million shares. That means TATTF, today, would have to issue an additional 6.60 Million shares which would bring their total outstanding shares to 6.55M(TATTF out. shares) + 6.60Million newly issued = 13.15 Million total outstanding shares. Their current market cap is $34.20 Million. $34.20M / 13.15M shares = $2.60 per share which equals a 4.87% return. Although its not a bad situation, it isn't one that gets me really excited. I'll pass.

benjamingrahamcracker said...

Furthermore, the best thing that could happen would be for the shareholders to vote against the acquisition. If that happens, then I would entertain the idea of owning stock in LIMC. The shareholder has more potential value in the company as a going concern. TATTF could bankrupt themselves if they acquire LIMC. I don't believe their balance sheet can sustain the purchase of LIMC. They are taking on too much debt. Not enough money flowing into the business and too much flowing out.

benjamingrahamcracker said...

One last point to mention. I'm a value investor and don't rely on micro and macroeconomics. BUT, I'm not blind to it. TATTF is an Israeli owned company. Israel has been performing target practice lately and many believe that a war can ensue very soon (weeks) between Israel and Iran over the speech that was recently given at the UN by the Iranian President. If you don't think that could potentially hurt TATTF stock, you're irrational.

Bootstrap said...

Great post - these are certainly interesting times for value investors. Another opportunity for those who are interested is Thor Industries. Although it is not a net-net they do almost have half their market cap in cash and long term investments (which are actually ARS that aren't trading - normally they would be short term investments). Best thing - no debt!

Great blog - I really enjoy it. Keep up the great work!

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