Wednesday, December 19, 2012

Paulin Buyout

The oldest stock on this site's Stock Ideas page has finally made its mark. Three and a half years ago, I wrote about a little company called H. Paulin that traded at a massive discount to its net current assets. Yesterday, the company announced a buyout that saw investors generate more than a 400% return over this period!

There are a few lessons that can be taken from this investment opportunity. First, you get the best prices when you buy during market panics. Being a small, Canadian company in a slow-growth industry, Paulin rarely traded for a lofty price relative to its earnings or book value. But when the recession took the market by storm, it fell to a dizzyingly low level, offering up the perfect buying opportunity.

Second, it's important to look at the components of a company's earnings. In Paulin's case, its earnings were artificially low because it had a money-losing manufacturing operation dragging down results while a profitable distribution segment was hidden among the overall losses. As management cut resources to the manufacturing operation (e.g. capex), losses became smaller and the company's earnings grew.

Finally, buy at large discounts to net current assets. This was one of those sleepy net-nets with no looming catalyst and an entrenched (through dual-class shares) management. But due to the large discount and the fact that the company was not burning cash, the investor's downside was protected. As such, even if things had gone poorly for the business, shareholders who bought at a large discount to net current assets may have still made out okay. A portfolio made up of stocks like these is bound to do well over time.

Disclosure: No position

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