Monday, December 14, 2009

Energy Bolt

Bolt Technology (BOLT) sells equipment for measuring marine seismic activity. Despite a near 40% drop in revenue in the most recent quarter, the company has remained profitable throughout every quarter of this downturn. Furthermore, the company trades at a P/E of just 10 based on its last four quarters, and recently made it onto Forbes' 200 best small companies list.

The company clearly meets one of the most important criteria for value investments: solvency. The company carries no debt, has $33 million of cash (compared to a market cap of $95 million), and has shown an ability to scale down costs as revenues decline. Subtracting the company's cash from its market cap gives the company a trailing 12-months P/E ratio of just 6!

Looking only at the numbers, this company is a buy. Unfortunately, the numbers don't tell you the whole story. While the historical earnings record appears stable, the future is not so clear. This is because a huge part of the company's sales is based on strong energy prices. While not so obvious, this is an extremely important factor in the company's risk profile.

Energy prices are notoriously volatile, and while they have been quite high by historical standards in the last few years, there is no guarantee that this will continue. Historical earnings records are only useful as predictors of future earnings for products with stable demand (e.g. nuts/bolts, certain food/beverages etc.). This is why value investors prefer industries that are stable; the outlook can be predicted with more certainty, resulting in a much smaller range (or confidence interval) of the company's intrinsic value. Companies in energy exploration are in the exact opposite realm. Furthermore, Bolt's recent earnings history contains data only from years where energy prices have been relatively high, making their extrapolation into the future problematic.

That's not to say Bolt can't turn out to be a terrific investment. If the oil price remains high by historical standards, demand for Bolt's products may reward investors for years to come. Unfortunately, predicting the price of oil is a difficult task indeed. If the price moves below the range it has shown in the last few years, Bolt's historical earnings may prove to be a useless guide of the future, resulting in future earnings far below what the investor has come to expect. The value investor needn't place a bet as to the future direction of energy prices; instead, he can stick to stable industries with more predictable earnings to better guarantee that he is buying at an attractive price.

Disclosure: None

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