Wednesday, March 2, 2011

Comtech Telecom: Past Or Future

Comtech Telecom (CMTL) provides telecommunication systems and services. The company trades for $785 million despite a net cash position of $400 million and operating income over the last four quarters of $130 million. This type of balance sheet strength and earnings power (relative to market value) is very inviting for value investors, but they should investigate further in order to be fully aware of what they're getting into.

As value investors, we're conditioned to place a heavier emphasis on past, as opposed to forward, P/E ratios. Indeed, market research does suggest that future estimates can be way off base. Furthermore, it has been empirically demonstrated numerous times that a portfolio of low P/E stocks tends to outperform the market as a whole. Nevertheless, this is no excuse to wear blinders when it comes to estimating a company's future earnings.

In the case of Comtech, it relies on the US government for more than 2/3's of its revenue. And a good chunk of this revenue is at risk, as a couple of important contracts have recently expired. As noted by Comtech's CEO on the company's first quarter press release:

"...[S]ales to the U.S. Army are expected to decline in future quarters..."

This example also underscores the risk of investing in companies with heavy customer concentration; at the end of 2008, the company traded at $45/share while today it trades at just $28.

Buying a company that's about to experience revenue losses isn't always a bad thing, however. A shrinking business can free up assets for shareholders, as seen with Nu Horizons. But for shareholders to profit, they are much better off buying at a large discount to book value. Doing so would allow shareholders to benefit from these freed up assets even if they are sold at a loss. In Comtech's case, however, the company trades at a premium to book value, so the company will actually have to generate half-decent returns on its assets in order for shareholders to make money over the long term.

A portfolio of low P/E stocks will outperform the market. However, investors can do even better than a passive portfolio of this nature by weeding out the companies with the most risk. This requires additional effort and due diligence, but positions the investor for the kind of returns that a simple, passive portfolio based even on low P/E stocks can't provide.

Disclosure: None


Paul said...


Check out MNDO. Market cap of about $57 million. Tilson Dividend fund has a small stake. Company seems to be shareholder focused and they paid a special dividend in 12/09. Positive operating income - above pre recession levels. $18 million in cash vs $6 million in total liabilities. company has been buying some shares back. On the downside, it is trading about 2x 5 year BV.

Saj Karsan said...

Hi Paul,

MNDO does look good based on current earnings, but this has been an abnormal year. Personally, I like to see steady and consistent profits over a business cycle before I buy into an earnings play.

Paul said...

Thanks, Saj. I really do admire your input.