From The Mailbag: Glacier Media

Glacier Media (GVC) is a media and information company. The stock has a P/B of just over .5, with a P/E of 7, and a debt to capital ratio of 28%. Sounds cheap right? Not upon closer examination of its balance sheet.

While the company has a book value of equity of $300 million, included in that balance is an asset of $229 million of Goodwill. Also included in that equity balance is $162 million of intangible assets. These facts by themselves don't neccessarily mean that Glacier's book value is worthless; in fact, it's entirely possible that the company's true intangible assets are understated by these values. However, the fact that intangibles play such an important role in the company's book value raises the importance of the investor's understanding of the company.

The fact that there are no hard assets (such as cash/AR/real-estate) to fall back on in case earnings fall through means the company better have a moat of some sort to protect its earnings power. But the investor can only ensure that the company's earnings power will continue into the future if the company falls within the investor's circle of competence. If the investor isn't sure, then this type of investment is not for him: while intangible assets are sometimes worth substantially more than their balance sheet carrying values, sometimes they are worth substantially less. No matter what the company's current earnings may be, to avoid ending up on the wrong side of these two possibilities, the investor should stick to companies which either fall within his circle of comptence, or that have downside protection in the form of hard assets.

Because Glacier Media appears cheap across the standard value metrics, it serves as a perfect example of how stock screens are just a starting point for value investors. Traders and speculators may do no further analysis if a stock screen shows them what they're looking for. Value investors, however, need to understand the business before they can jump into a stock.

Interested in an alternative perspective on Glacier Media, or another stock of your choosing? Our sponsor, INO.com, is offering our readers a free analysis of a stock of their choosing here.

Disclosure: None

Troughing Now Or Later?

During recessions, not all industries experience the pain (and the enusing recovery) at the same time. Some industries get hurt first, while others don't feel the ripple effect for several months. With Wall Street's over-emphasis on the importance of current earnings, understanding these cyclical troughs can help value investors profit.

Consider Hammond Power Solutions (HPS.A), a stock that has twice been discussed on our Value In Action page due to the fact that its price fluctuates far more than does its business value. In the last quarter of 2008, while banks and most companies related to the housing industry were struggling to meet their obligations, HPS reported record sales and profits, prompting its Chairman and CEO to state the following in late March of 2009:

"As our 2008 results illustrate, HPS has come through these challenging economic times relatively unscathed."

As a result, its stock price appeared to trade close to its intrinsic value in a pretty weak general market, as we discussed here. But fast forward four months, and it appears the company is all of a sudden experiencing a downturn. Net earnings dropped 87% year over year in the 2nd quarter of 2009. The Chairman and CEO has completely changed his tune, as evidenced by the following new statement on July 16th:

"Going forward, it is fair to say that the global economy is performing worse than even our most pessimistic forecasts of six months ago."

The stock price has of course responded to the current earnings environment for this company, rather than its long-term earnings power, as it is down over 20% in the last two months. If the stock continues to fall due to drops in demand that are of a short-term nature, it will once again provide the long-term investor the opportunity to purchase a good company at an excellent price! Buying companies that are in the midst of cyclical troughs is an excellent way to derive long-term profits*.

*The tricky part, of course, is ensuring a company is indeed going through a cyclical and not a secular downturn, and has a financial position and cost structure such that it can survive/thrive until better times return.

Disclosure: None

Volatility Offering Opportunity

In March of 2009, panic in the market led to an enormous number of value opportunities. Believers in market efficiency would be hard-pressed to justify some of the depressed valuations prevalent in the market at that time. Some companies have already posted tremendous gains in the four months that have passed. One such example is Spartan Motors (SPAR), designer and manufacturer of heavy-duty vehicle chassis.

The auto industry is clearly going through a tremendous slump, but investors went overboard in punishing the valuations of many of these stocks. Since hitting its low in March, the stock has already quadrupled. But how was an investor to know that SPAR was undervalued?

The company traded for just $75 million in March, but had cash of $14 million, receivables of $76 million, and inventory of $87 million, for a total of $177 million. Meanwhile, the company had total liabilites of just $90 million, for a difference of $87 million. In other words, the company could be purchased for its inventory, with its fixed assets, R&D, and customer relationships thrown in for free. For a company that has remained profitable throughout this downturn (including 2008 operating income of $69 million), this represented a tremendous bargain.

While most companies have recovered from their lows in March, many have not. Fifty-two week low lists continue to show investors which stocks are out of favour. Of course, not all out-of-favour stocks offer value, but the current environment still offers plenty of upside to those willing to make the effort to uncover the diamonds in the rough.

Disclosure: None

The Mainstream Media

We've not made it a secret on this site that we don't believe the mainstream financial media helps the average investor. Their focus on the short-term, their tendency to sensationalize/exaggerate (both to the positive and to the negative), their emphasis on their anchors' personalities (over the substance of the information provided), and their focus on the most popular/hot/trendy sectors and companies does a disservice to the investor looking to outperform.

Thanks to the internet, we can tell that we're not alone in taking this view. A pair of writers at Zero Hedge have written an eloquent article on the subject in the form of an open letter to the financial media. The letter serves as a must-read for those who rely on the mainstream media for any sort of investment advice.

Readers of CNBC online will also enjoy Zero Hedge's spoof of CNBC's website, located here.

Usual or Unusual?

As noted by Ben Graham, when analyzing a potential investment, it's important to incorporate several years worth of operating earnings. This is due to the fact that in any one year, various external or internal factors could lead to annual numbers that are not representative of future results.

In performing such an analysis, investors will note that many companies designate certain expenses as 'unusual'. Common types of 'unusual' expenses include Goodwill writedowns (i.e. the company purchased another company some years ago and now realizes it overpaid for that company) and restructuring costs.

For many companies, perhaps these are indeed unusual expenses and will not occur again. For other companies, however, 'unusual' expenses seem to be a perfectly normal part of business as usual.

Consider New Frontier Media (NOOF), producer and distributor of adult-themed video-on-demand programming. Excluding what the company deems as unusual expenses, the company has earned operating income of $87 million over the last 8 years, averaging to $11 million per year. In five of those eight years, however, the company recorded 'unusual' expenses. Incorporating these expenses, NOOF's average operating income over the last 8 years reduces to $8.5 million, a reduction in value of over 20%!

To avoid making valuation mistakes, it's important for investors to consider several years worth of earnings (preferably an entire business cycle) and to seriously consider unusual expenses to determine if they are relevant in determining the company's current earnings power.

Disclosure: None

The Psychology Of Human Misjudgement: Authority Misinfluence

Charlie Munger is Warren Buffett's right hand man at Berkshire Hathaway. Over the next few weekends, we'll be summarizing the text he authored titled "The Psychology Of Human Misjudgement", where he describes some of man's tendencies. By understanding and learning from these tendencies, we better equip ourselves to avoid psychological biases when investing.

Man has a follow-the-leader tendency. While this can often lead to effective group operation, particularly when the leader is proficient, it can lead to disaster if the leader is wrong or if the leader's communication is misunderstood. This is due to the fact that followers will often ignore logic in the belief that the action as suggested by the leader must be correct.

Munger describes several situations, from the humourous to the disastrous, where the instructions of leaders were clearly wrong or misunderstood, yet the followers would perform seemingly illogical acts in the belief that the leader must know what he's doing. Hitler's ability to convince a group of people to commit genocide is a particularly grave example.

Because people will follow leaders whether they are wrong or right, it is extremely important to choose good leaders. Many CEOs are able to remain in power because of the respect they are afforded due to their positions! Munger notes a specific example where a CEO was blind to reality but remained at the helm of his company simply because of the respect afforded to his position.

The Psychology Of Human Misjudgement: Use It Or Lose It

Charlie Munger is Warren Buffett's right hand man at Berkshire Hathaway. Over the next few weekends, we'll be summarizing the text he authored titled "The Psychology Of Human Misjudgement", where he describes some of man's tendencies. By understanding and learning from these tendencies, we better equip ourselves to avoid psychological biases when investing.

Skills degrade when not practiced. The antidote to this unfortunate reality is to frequently practice useful but rarely used skills. This is akin to how pilots use flight simulators to practice rarely-used skills that they can't afford to lose.

Munger argues that if man does not practice his existing skills, his learning capacity will also shrink. This is due to the fact that he creates gaps in the framework he needs for understanding new experiences. A wise man creates a checklist of his skills, to ensure they are kept sharp.

But this tendency does not treat all skill bearers equally. If a skill is practiced diligently until fluency is reached, it degrades much more slowly and is refreshed much more quickly than if a skill is quickly crammed to, say, pass an exam.

With advanced age also comes more severe deterioration of skill. But an individual can maintain well-practiced skills to even a very old age. Munger also argues that continuous thinking and learning can help delay the deterioration that is inevitable.