Individual Investors Can Make A Difference

Adams Golf (ADGF) has been discussed a few times on this site. Usually this happens when it trades at a large discount to its net current assets, and when it subsequently appreciates. One long-term investor (and by today's standards, a three-year investment would be considered "long-term"), grew increasingly frustrated by the company's compensation practices, and managed to do something about it!

"Fore"midable and Low-Risk Returns

Just nine months ago, we discussed Adams Golf (ADGF) as a potential value investment due to the severe discount at which the company was trading relative to its net current assets. Since that time, the stock has rallied over 40%. But more impressive than the return (after all, the general market has rallied over this period) is the low risk at which this return was achieved, due to the use of the all-important margin of safety.

What is important to realize is that this 40% jump in the stock price did not arise because the company had some positive surprise. To the contrary, the company has continued to rack up quarterly losses, and even settled a litigation dispute pretty close to the worst-case payment it would have had to make had it lost in court (though it likely did save on attorneys fees by settling).

The reason for the large rise in the stock's price is due to the fact that the market was totally mis-pricing the stock to begin with. Nine months ago, you could buy this company for $19 million even though it had cash of $3 million, $23 million owed to it by its customers and another $23 million of non-perishable inventory (golf clubs etc.) against just $14 million of liabilities.

In the last few months, the company has had to sell some of that inventory at a loss, and has agreed to pay $5 million to settle a lawsuit. As such, its net current assets reduced from about $35 million to $29 million. Despite this, the stock price has risen dramatically, as the company's market cap has recently spent some time trading just under $30 million. The massive margin of safety on this stock 9 months ago has allowed the investor to profit despite the absence of any company specific positive news!

Now that the stock trades for its net current asset value, ADGF becomes the latest stock to move from the Stock Ideas page to the Value In Action page. But the lack of discount to its net current assets doesn't mean all value investors who own it should sell it, however. An opportunity may remain for those who know the company well, including its products and its position relative to competitors. In other words, it may still be cheap relative to its intrinsic value. But at this price point, the value investor should ensure that the company is firmly within his circle of competence to avoid undue risk to his principal.

Disclosure: None

Leisure Suit Lawsuit

Ben Graham noted that stocks of companies with some lingering uncertainties tend to have their valuations over-punished by the stock market. A pending lawsuit is one such example of a "lingering uncertainty". For this reason, many companies would rather settle legal claims that cast a shadow over the company's valuation even if they think they can win them. However, in such uncertain situations, no liability is recognized on the balance sheet. Nevertheless, investors who take the time and effort to read the legal proceedings that the company discloses put themselves in a position to reduce - or even eliminate - the financial uncertainties.

Consider Adams Golf (ADGF), a designer and distributor of golf clubs. Two days ago, the company reported the settlement of an old claim; the company will be out $5 million as a result. For a company with a market cap of just $19 million, this is a material cash outflow. But for investors, this should come as no surprise. A careful reading of the company's previous notes to its financial statements would have revealed, among other things, the following:

1) The company was insured for exactly this type of infraction for up to $50 million

2) One of the insurers, which was to cover $5 million of the $50 million, claimed a breach of contract and was unwilling to pay

When we previously discussed this stock as a potential value investment two months ago, an astute commenter raised the subject of this lawsuit. The answer a few comments later was that in all likelihood the lawsuit would cost the company $5 million. As such, the company's disclosure two days ago that it would take a $5 million charge to settle this lawsuit came as no surprise. By factoring in this cost before it was even recognized by the company, a more educated decision could be made by the investor as to whether the company was indeed undervalued.

Of course, surprises are still going to occur. Not every event, legal or otherwise, can be foreseen. But by doing their research (by reading the company's disclosures and its notes to the financial statements), investors can minimize risk and reduce uncertainty. In doing so, they can improve their accuracy in determining a company's value.

Disclosure: Author has a long position in shares of ADGF

Consumer Meltdown, Or Temporary Lull?

While the cash for clunkers program did provide consumers with a temporary incentive to open their wallets, consumer spending is expected to remain tepid over the next few months. Consumer confidence is low, unemployment continues to rise, and consumers are increasingly using their incomes to pay down debt. As a result, the market has punished many stocks that sell leisurely consumer goods. But conditions like these tend not to persist for long. In the meantime, investors are offered the opportunity to buy such companies for what appear to be tremendous discounts to their intrinsic values.

Consider Adams Golf (ADGF), designer and distributor of golf clubs. The company has lost money in three of the last four quarters, as customer inventory reductions and reduced consumer demand has caused revenue to drop significantly. But is the company in such dire straights as to warrant its current market valuation? You be the judge.

ADGF trades for just $19 million, but has current assets of $50 million versus liabilities of $14 million, which includes just $5 million of debt. Due to Mr. Market's obsession with current earnings, ADGF offers investors a chance to purchase a cash flow positive (referring to second quarter cash flow from operations) going concern at a discount to its liquid assets.

It could be a while before consumer spending returns to levels where Adams Golf can once again generate net income of several million dollars per year. But with the stock price at this level, investors don't need that to take place in order to make money. As the company aligns its cost structure to the lower level of demand, it will likely return to profitability in the near future, rewarding investors who focus on the long term and who cover their downside risk by purchasing liquid assets with a healthy margin of safety.

Disclosure: Author has a long position in shares of ADGF