3/16/2011

continued “The Art of Winning an Unfair Game”

some of my additional thoughts on the overlooked, underappreciated and undervalued use of certain financial metrics to help us find overlooked value creation.


The enterprise value dropping quicker than the market value may help provide a source of mispriced stocks with the belief that the pieces that drive the EV lower are not valued and given the immediate market price adjusting recognition.

This “Discount/Premium Ratio” as I will name it is simply EV/Price. I know I’m not telling you something new but tracking and understanding how and why the relationship between EV and Price change over time could be an initial step that leads to uncovering new overlooked ideas. One small part of this value search may be driven by mean reversion when the market ignores EV value drops driven by debt pay down, share count reduction or cash buildup and the EV to price ratio needs to catch up or normalize. Assuming the operations are relatively the same I would think this relationship over time should remain correlated. So the relationship disconnect between EV and price may be a source for inefficiently priced stocks. The market may have overlooked the benefit of the positive value creating metrics that are driving down the enterprise value. Debt pay downs from cash flow or asset sales is not an immediate market moving piece of data but does immediately increase equity.

For example the price of a sound company with no operational change may drop let say 20% over 3 years but the enterprise value dropped significantly more like 35%.During this uncorrelated move the company has strengthened their balance sheet by either doing all or some of these activities; paying down debt, reducing share count or increasing the company’s cash balance thus reducing the enterprise value faster than change in the market price. The market may be overlooking these beneficial changes improving the company but have yet to be reflected in the P/E ratio or some other popular metric that most investors and media give more weight to measure a company’s current or future value. The market is not likely to give the same market price improvements to a company that is paying down their debt, buying shares back at opportunistic prices or building up cash. The financial media and many in the investing public prefer or give far too much weight to net income regardless if it’s based on accrual accounting earnings. The financial media and many of the market participants get more excited by growth even if it’s reducing ROIC and completely ignoring the diluting impact of excessive management options or issuing stock and new debt used to satisfy managements desire to do something by acquiring a company that ultimately destroys value long term.

Quick set of ideas that have been reducing debt or reducing share count or increasing cash in combination or some coupled with YOY revenue increases. Please give me some time to post more fundamental related data and any relevant qualitative information. These potential watch list ideas were put down last night

DGII (Price = 9.40)

BBOX (Price =33.34)

HCKT (Price = 3.60)

CLRO (Price = 4.90): Share count reduction over the past 5 years, debt reduction from 2007, cash build from 2009 but the stock has moved 65% along with 35% YOY quarterly revenue improvement with a reduction in margins.

CLRO was mentioned under the price of 3.00 but still has value
http://shadowstock.blogspot.com/search?q=clro

Long CLRO

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