Friday, May 7, 2010

"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


optionsnut said...

Isn't it funny the value we place on current information vs past information. Regardless of importance.

I bought Adams a few months back around $3.5 because i liked the space and felt that it was just below book and could still generate a profit in the next 12-18 months based on the sector lagging the 'economic recovery'.

My buy on this was based on originally seeing it here and after watching my favourite ALDA jump after i sold early for 'personal reasons' decided Adams was the better current play.

This article made me second guess myself and debate 'panic selling'. What a difference a few trading days makes.

Based on current info i will hold for a while longer as the company is still a going concern and can generate a good ROE even at today's price.

note: i rarely buy most of your holdings but if i do its well after 3-6 months they are out and i have read a few reports on Edgar/Sedar. While i like your findings i do not place blind faith in your picks as that would be foolish.

Thanks for your continuing efforts in creating one of the most 'comma inducing' blogs in cyber space!


Saj Karsan said...

Hi Derek,

Sorry to make you panic! Indeed, I understand how sentiment can shift rather quickly. Good job countering these emotions...that's essential for good investing!