Tuesday, June 1, 2010

What's Old Is New Again

Stock price volatility benefits the value investor. Stocks that are especially volatile can provide investors with entry points that provide a margin of safety, and exit prices that reward the investor for "putting up with" the volatility. One stock exhibiting such tendencies is Acorn International (ATV), a distributor and marketer of hundreds of products through infomercials, catalogs and other channels.

Long-time readers of this site may recognize this company already. Last year, the company traded at a substantial discount to its net current assets. When business conditions stabilized, the stock price drove right through its net current asset value, and shareholders were further rewarded as the company paid out a portion of its cash reserves in a special dividend. The stock proceeded to trade at a range that made it difficult to tell if the company was under- or over-valued, allowing for an exit point for value investors.

Last week, however, as the company's first quarter results came in below expectations, the stock once again plunged to a level far below its net current asset value, to lows not seen since November of 2008. But while the company traded for under $100 million following the earnings report, it holds current assets of $194 million ($120 million of which is cash) against liabilities of just $35 million.

Often, a company trading at this kind of discount to its current assets is losing money hand over fist. But Acorn expects to pull in net income of over $12 million this year, even after a first quarter result that was below expectations. As the company has now worked through much of its older inventory, it can now focus on selling items with better margins and returns. With so many products to choose from, the company has an inherent advantage (compared to a one-product company, for example) in being able to choose to promote the most successful products, which helps ease the strain on the company's budget planner.

As an added bonus to investors, most of the cash the company holds is held in Chinese yuan, which may appreciate relative to the US dollar in the near future, as many are reporting. But while the short-term is inherently difficult to predict, over the long-term the Chinese yuan should definitely appreciate relative to the US dollar due to the high productivity gains Chinese workers are expected to experience relative to their US counterparts (due to the low starting point of the Chinese worker).

This stock is not for the faint of heart. Its price can fluctuate severely on a day-to-day, week-to-week or month-to-month period. As such, the mainstream finance industry would tag this stock as risky and leave it at that. But for value investors, price volatility is not the same as risk. To the value investor, the value of this company does not change nearly as dramatically as the company's price, offering opportunities to buy when the company trades at a discount.

Disclosure: Author has a long position in shares of ATV


Ankit Gupta said...

It might not matter at these prices, but looking at the last 3 years of financial statements, accounts receivable has shrunk relative to revenue however inventory has risen compared to 2007 ending levels. If you look at inventory turnover, 2007 turned over quite a bit, but then decreased in 2008 and 2009. I have not dug into the quarterlies or anything, but if someone else has more insight, I'd love to hear what you found.

Ankit Gupta said...

Saj - here's a question for you when playing stocks trading below NCAV.

As Graham would teach us, we should only buy equities at a price that we would be willing to pay for the entire company. You need a margin of safety in there as well.

I understand that when it trades below NCAV and value investors buy it, it's because they believe the liquidation value is greater than what it sells for.

The issue I have with this is that if the company is going to indefinitely be burning cash because of unprofitable operations, the forward looking value should be even less. Yes, the business is worth more dead than alive and so if you calculate liquidation value, it could be a good buy along the way down as prices correct. The flaw in this is that unless you actually liquidate it, the company just continues on its way down to 0. In order to liquidate a company of this size, you need to have a sizable amount of capital and you will pay a premium to the current price to be able to control 100% of the company. Your other choice is convincing management and the board that operations should be halted and the business liquidated - good luck with that.

Taking a step back and looking at this, do we just step in to make quick gains as the price corrects itself or do we say that it's going to 0 and so it's not worth owning?

rayhaan said...

food for thought indeed! Ankit. now i understand wot mr.lynch meant wen he said nothing is easy in this bizness. But wot if the management has a substantial stake in the biz? Doesnt it reduce d risk?

Ankit Gupta said...


That is definitely a positive signal - try to think about other reasons why they might have done it though.

Say you're the CEO, CFO, or even a board member. You already have company stock and you get a nice fat $300,000 salary plus benefits. For you, it might be worth buying the stock even if it's going to decline as an investment. Let's say your company is going to have to raise money and you see this coming up in 6-12 months. You need this to happen so that you don't have to take a salary cut.

You buy the stock, show some good news or progress, investors see insider buying and the stock moves up. You raise a round of capital and now you've ensured your salary for hopefully a few more years. That $50,000 might have risen to $100,000 or even fallen to $25,000, the fact is that you don't care. You just want that salary and if it moves up, that's great, makes the situation even better.

If it fell 50%, you can save some on taxes, but for $25,000, you just helped keep your salary and you can argue that it was for the greater good because it helped keep the salaries of your employees. If you coordinate this among management and the board, it's not hard for it to actually make an impact.

What you should look at there is the length of insider ownership. If someone has been running a company well, owns 30% of it, etc. and continues to allocate capital well, then that says more than someone who just recently bought a coordinated total of 5-10%.

Insider ownership is a valuable tool, but you should remember that many ships have sunk and they still point up while at the bottom of the sea ;)

Ankit Gupta said...

Really good article written by Mr. Graham himself on the topic of liquidation: http://www.forbes.com/2008/10/23/liquidate-rich-assets-cz_bg_1023forbesarchive2.html

Saj Karsan said...

Hi Ankit,

I agree it's a good idea to keep an eye on inventories, but for this company we are still looking at only just over a month's worth of inventories.

I totally agree with your statement that you have to be careful that the company is not burning cash, even though it may be cheap on an asset basis. Some more of my thoughts on the subject are here: http://www.barelkarsan.com/2009/06/dont-just-buy-any-net-net.html

rayhaan said...

thx 4 d explanation ankit! i guess taking this logic a step 4ward ,maybe listed indian family companies like archies wid 60% promoter holding wid gud capital allocation history might make gr8 investments, wot do u think saj and ankit?

Saj Karsan said...

Hi Rayhaan,

I'm afraid I don't know much about Archies at all, sorry!

Paul said...

Looks like this one is trading at a bigger discount to it's assets. Although it's worrying that the a director decided to step down