Monday, May 25, 2009

Passing The Smell Test

Studies have demonstrated that companies with high standards of corporate governance outperform those with weak standards. However, individual investors can hardly be expected to be experts on corporate governance (though there are some steps they can take to mitigate this). Nevertheless, by employing a little common sense, investors can scratch off potential stocks from their buy list when things just don't smell right! As an example, let's look at Meade Instruments (MEAD), a leading maker of optical products such as telescopes and binoculars.

Meade trades at a discount to its net current asset value. But that's where the appeal of this company ends. In addition to having lost money in each of the last four years, there are a number of troubling signs. Its CEO resigned in February, which by itself may not be a significant factor, except for the fact that the CFO resigned just one month later. Two more directors have also recently resigned, pushing the company into non-compliance territory with the Nasdaq exchange, as the company now no longer has three independent directors on its audit committee.

As if these issues weren't enough, the company is also in violation of its debt covenants (i.e. it has breached certain agreements with lenders). Furthermore, the company does not seem very forthcoming with its financial information. The latest quarterly results are from the quarter ended November 2008, which means it has now been almost three months since a fiscal quarter has ended, and there are still no results to be seen. On the last conference call, management alluded to the fact that demand is higher than capacity, but could not provide a backlog number in dollars. (Contrast this with companies Hammond Power and Canam, where backlog numbers can be tracked over time, which serves as useful information for shareholders looking to estimate revenues going forward.)

It's entirely possible that Meade could turn itself around and offer current investors excellent returns. But the director/management turnover, financial reporting, and covenant violations suggest shareholders would also be advised not to swing at this particular pitch.

Disclosure: None

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