Friday, May 8, 2009

Hammond Runs Its Course...Again

For value investors, a great company does not necessarily equal a great investment. Why? Because the price of that investment must be compared to its value. Such is the case for Hammond Power Solutions (HPS.A), a manufacturer of transformers and magnetics. We saw that in 2004 HPS appeared to trade at a large discount before it promptly appreciated; it appears to have done so again.

When we discussed this company back in December, it traded at just $6/share and therefore appeared to trade with a large margin of safety. While the company has continued to perform well, the margin of safety has been almost erased, thanks to a 60% run-up in the share price over the last 4 months.

In the company's recently reported first quarter results for 2009, sales continued their ascent, having risen 14% from the same period one year ago. However, there are some signs that the economy is finally catching up with this company. Hammond Power's backlog (an important measure we considered when evaluating the state of Canam (CAM)) is down 20% from last year, as orders aren't being replaced as quickly as they are being filled. Excess output capacity in the industry is also pressuring prices downward, suggesting tough times may be ahead.

While the company's ROA and ROE continue to impress, today's share price reflects much of the value in this company. While many may argue that the company's growth prospects position the stock to do well in the future, value investors prefer to avoid paying for such assumptions. 

With the market in the state it's currently in, there is great value to be found (i.e. stocks with margins of safety) and therefore hanging on to stocks that now appear to approach fair value doesn't appear to constitute sound judgement. Value investors must constantly monitor their positions on the chance that Mr. Market is offering a fair price for a company purchased at a large discount.

Disclosure: None

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