Aldila: Is this a value play?

Aldila, a designer and manufacturer of graphite golf shafts (ALDA on the NASDAQ), is showing promising signs of being a value investment according to some basic measures of value.
Aldila's stock is trading with a trailing price to earnings ratio of less than 2.5, a price to book of less than 1 and pays a quarterly dividend of 15 cents, giving it a lofty dividend yield of around 11% based on the current stock price.

Looking at value indicators is only my beginning step in determining whether a stock qualifies as a value investment. Value indicators such as low P/E, low P/B and high dividend yields are used as signs of potentially undervalued securities. Following Benjamin Graham's lead, to truly understand whether the stock is undervalued, the intrinsic value of the company should be calculated and compared to its current market price before making a purchase decision.

In addition to calculating the intrinsic value of a company, I take notice of management's ability to allocate capital effectively. It's instructive to note that Aldila's management made a decision to pay out a special one time dividend of $5 per share to shareholders in March of 2008. This action demonstrates that management decided that it would be in the best interests of shareholders to pay out the excess cash. Readers of Warren Buffet's notes to shareholders know that capital allocation is a key management decision and managers that do this well are in short supply. I applaud Aldila's management for resisting the temptation to hoard the cash reserves or worse to squander it on capital assets or projects that would not create value for shareholders.

So why is Aldila's stock trading so cheap? It seems that one major reason is the slumping sales figures for the company. Revenues reached a peak for the company of $77M in 2005 and have fallen by 6% to $72.4M in 2006. Revenues continued to fall by 4.5% to $69.1M in 2007. The latest quarterly report in March 2008 shows a huge year over year period decline of 19% in total sales.

Trying to accurately predict what will happen to upcoming sales for a given company is anything but an exact science and yet this is one of the most popular activities on Wall Street. It's no wonder that predicting sales accurately has humbled many excellent analysts. Benjamin Graham has taught us to avoid forecasting and instead to use factual data in calculating company valuations. One approach to use with Aldila is to evaluate whether something fundamental has affected their business in a way that would permanently impair their operating margins. If the answer is no, one reasonable approach is to normalize the sustainable earnings over a complete business cycle and to use this result in calculating the intrinsic value of a company.

In my next post, I will continue to reveal my personal calculation of the intrinsic value of Adila's public stock.

Disclosure: None