How to invest

Written by

Jae Jun

Back in 2008 and 2009, I had a lot of fun going through 200 of the best small companies from the annual Forbes magazine listing.

Trying to go through 200 companies in a few weeks meant I was constantly reading and thinking, which helped me in my outperformance of the market.

With a lackluster portfolio performance this year, along with my day job becoming more hectic and demanding, it’s time to try and go back to basics and see whether I can build a better portfolio for next year while this volatility remains.

Making a List of Stocks and Writing Simple Notes

What I’ve been doing is just jotting down basic notes and valuation estimates in a simple watchlist style on my google docs.

Here is a PDF version of what I’m talking about and here is an excel 2007+ version.

My idea for now is to do something similar with the 2009 list of 200 best small companies.

2009 Best 200 Small Companies – Today

Of the 200 from 2009, 14 were bought out. A 7% rate of being bought out is fairly good and shows that this list has something going for it.

OK. Less talk and more action.

Here is the skeleton spreadsheet I created based on closing price of September 13, 2011.

There are 81 stocks below or at 2009 prices and 105 stocks above 2009 prices.

• 3 stocks have tripled (TWIN, LDSH, ATRO)
• 6 stocks have double (AIRM, TIBX, LQDT, CRR, LXU, IDCC)
• and 27 stocks sit above 50% gains

Download the Excel for the Status

Download the excel 2007+ file and get cracking.

We can make this a collaborative group project. If you find anything particularly interesting, make a note of it and jot it down in the forum I created for this.

US Listed Japan ETF’s Not as Cheap as You Think

Investing in Japan has been on my mind the past week, but so has the crowd. What this means is that American investors have not been fleeing.

A quick way to judge this is to simply compare the drop of the Tokyo Stock Exchange (TSE) Index compared to the ETF’s that trade on the US exchange.

The first three days following the disaster, the TSE fell 22%. Compare this to the iShares MSCI Japan Index (EWJ) which fell around 12%. Small cap Japanese ETF’s JSC, SCJ and DFJ fell roughly 14% a piece.

This is a big disparity and shows that the crowd is very willing to pick up shares in Japan.

Despite the 14% fall, the current prices really only go back to Dec 2010 levels which is not cheap to begin with. Add the currency risk into current prices, and Japan is not the bargain you think.

Are Japanese Stocks Cheap for US Investors?

As a quick example, assume that Panasonic (PC), at the 52 week high price of $16, is fairly valued. The point of this exercise will be to see whether current prices reflect value for US investors. I am not able to purchase stocks off the TSE and my assumption is that most people cannot as well.

Geoff Gannon made a great point about currency risk and how the overvalued Yen affects an investment.

How?

Currently, 1 USD will get you 80 Yen but by looking at the conversion rate over the past 2 years, it looks like the appropriate rate should be 1 USD for 95 Yen.

Geoff took the normal rate to be 1 USD : 109 Yen, so my value is even more conservative.

Using the 95 Yen value, the Yen at the moment is 19% overvalued. In other words, Japanese stocks could lose 15% of its value simply based on currency conversion alone.

Apply this 15% drop to Panasonic and the theoretical fair value comes out to $13.60. At the current price of $12, the potential upside for Panasonic is 13%. Not the best opportunity you may have been thinking about.

If you include a 25% margin of safety, since EVERY investment requires a margin of safety, then the buy price is $10 which Panasonic does not satisfy.

Japan has Historically been Cheap

You could argue that the original fair value of $16 for Panasonic is much to low to begin with. If I perform the above calculation in reverse, the fair value of Panasonic would have to be $20 for the current price to offer value.

The problem however, is that Japan has always been cheap. If you believe that Japan is cheap now, then you should have believed that Japan was cheap before the earthquake.

If  you did not have any positions in Japan before the disaster, it just means that you had better places to put your money. Put another way, it wasn’t that cheap.

Consider that when deciding whether your next Japanese stock is a value trap or opportunity of a lifetime.

Don’t let me discourage you though. I am looking through a list of Japanese ADR stocks hoping to find a no brainer.

Since I can not purchase stocks on the TSE, my best bet is to find an ADR. The universe is much smaller, but there are still plenty of ideas and you have a much better chance of finding a diamond with individual stocks rather than the Japanese ETF’s or closed end funds such as JOF.

Japanese ADR’s to Study

This site provides an outdated list of Japanese ADR’s and I have removed the stocks that no longer trade in the US.

Download the Japanese ADR stocks for excel. It has over 70 stocks you can look through. Most of them have zero volume on the OTC but it will be a good exercise to go through them.

For more Japan investing thoughts, here are some additional links that may interest you.

• Can Turtles Fly blog also has a post up on Japan
• Buy Japan / Investing in Japan Q&A by Geoff Gannon

Disclosure: None

I always look forward to the various Forbes Best 100 lists that are published each year. Although a little late, I’ve gone through the 2009 100 best mid cap companies ranked by Forbes hoping to find and build a list of well run companies.

There is no 2010 version as Forbes has either stopped publishing the mid cap list or they must have forgotten about it. Hopefully somebody that works there will read this and get things rolling for the 2011 list.

Of the 100 mid cap companies, 8 companies have been bought out within 1.5 years since this list was created, 62 made it to the valuation stage while the other 30 were dismissed as I found it too hard to value or the company made it onto the list due to one excellent year of operations. I looked for consistency in this list of companies.

Out of the 62 companies that were valued, the process was done quickly by looking at the cash flow, margins, CROIC and the other investing metrics I consider important. Only 3 companies came up as being undervalued based on DCF, Graham formula and EPV.

• Aeropostale (ARO)
• Amedisys (AMED)
• Tessera Technologies (TSRA)

Aeropostale (ARO)

A retailer of teenage apparel priced lower than Abercombie and Fitch and American Eagle.

Although the price of its products are below that of the competitors, the business operation is anything but. 2010 was another great year of operations for the company but seeing as how the increase in revenues and cash was due to cost reduction, I applied more “normalized” figures in my calculations. Before getting into the final valuation, here are some numbers that ARO has produced.

Over the past 5 years the median owner earnings growth is 36.8%, CROIC is 22.1%, FCF/Sales is 5.7%. Compare this with the 10 year median of 0%, 13.5% and 4.3% and you can see that over the past 5 years, ARO has done a great job in improving the business.

• DCF: $27.53
• Graham: $34.43
• EPV: $29.02

Amedisys (AMED)

Amedisys has shown up on my value screens as well as the magic formula investing screen many times.

The company provides home health services and has been hit due to the uncertainty of the medicare reimbursement under the new healthcare reform pushed by President Obama. What is certain is that until now AMED has produced amazing amounts of free cash flow.

Margins has decreased every year since 2003 when it was at a peak of 61% to 49.9% in 2010.

Median CROIC is 8.7%, FCF/Sales is 6.3%, wiwth ROA and ROE coming out to 8.9% and 15% respectively.

• DCF: $44.92
• Graham: $65.07
• EPV: $44.60

Tessera Technologies (TSRA)

Develops and licenses technology in micro-electronics and imaging and optics. Like AMED, TSRA has shown up plenty of times in my screens over the past year, but because the micro-electronic industry is not a particular favorite of mine, it has usually been left in the “too hard” pile.

However with the current valuation and the lack of love it is receiving from Wall Street, it may be worthwhile to start reading the reports.

TSRA Numbers are not consistent and there is wild fluctuations all way from the top of the financial statement to the bottom. A lot of expenses were used in litigation cases, but now that TSRA has won the case, the numbers should stabilize.

What I like about TSRA is that for a technology company it has been able to increase tangible book value every single year with CAGR growth of 22%.

• DCF: $27.00
• Graham: $26.01
• EPV: $22.18

List of Forbes 100 Best Mid Caps in America

• Download the excel version
• View and download the PDF version from Scribd

Disclosure

Long ARO at the time of writing

Gravity Ragnarok 1 Updated and a New Game Added

I’ve been following the activities of GRVY closely lately. I have all my google alerts set up to keep on top of news, updates and any further information about Ragnarok 2.

In the meantime, GRVY has released an updated version of Ragnarok 1 and expanded game availability to the majority of Europe.

GRVY has also become a major shareholder in another Korean game development company named Barunson Interactive. The purchase includes the rights to the game title by the name of Dragon Saga which is now live.

The latest update and Dragon Saga should allow GRVY to keep profits and cash flow break even during the RO2 development and launch period.

GRVY Counter Argument

A counter opinion from a commenter on Seeking Alpha that I found insightful and something to think about.

The problem with RO2 is that it’s a sequel, first of all, to an old game. To get some perspective on what sort of implications this has, imagine if a film maker made a sequel to an incredibly popular film from the 60s. It probably won’t attract young viewers, and will mostly target older viewers who loved the original and are looking for a nostalgic extension. You would probably expect, too, that people would be really concerned with how much it matched the original– after all, it’s really nostalgic for them so they have high standards about keeping ‘the same feeling’. You see that exact same thing about RO2. Just look up RO2 gameplay videos on youtube and read the comments. It’s pretty much nothing but page after page about how RO2 “isn’t the same feeling” as RO1 and how it has disappointed them. Just like how you might expect a movie of the same caliber to flop if it doesn’t run well with the one community that would be excited about it, there might be good reason in this alone to expect a RO2 flop.

To be fair to the above point though, there are cases where sequels to very old games that were significantly different have done really well. A particularly salient example is Starcraft 2 (a game of ATVI ). A lot of SC2 success though has to do with Blizzard’s reputation as a company, their monopoly in RTS (the type of game SC2 is), and their revamping of it to appeal to new users. Also, they did strive to keep some of the essential parts to attract hardcore old school gamers. Last but not least, they promoted SC2 as a highly competitive game with a tournament that boasts a $500,000 cash prize– needless to say, this attracted people too.

Also it should be kept in mind that when RO1 existed and enjoyed its popularity so much, the MMO industry was much, much less competitive than it is now. Back in those days RO1 was one of the few good options out there, especially of those available in Korea. Now there is such a massive range of MMOs to choose from, with some enjoying enormous popularity such as World of Warcraft.

Because MMOs are games that require enormous amounts of time, it is unusual for someone to play more than one MMO. This being the case, for an MMO to succeed people really have to prefer it to all other existing MMOs; this has become an extraordinarily tall order.

Mastech Holdings Not Feeling the Love

MHH certainly doesn’t receive much love. Slight improvements in the quarter showed that the economy is still in difficult times but the company is wading through the mess just fine.

Revenues up, demand for IT staff growing with $1.60 of the $3.30 stock price in cash and no long term debt.

Not much to worry about really. I must admit though that the value of MHH won’t be realized for a while with the economy in its current state.

With all the repositioning and resizing I have been doing to my portfolio this year, MHH has become my smallest position.

Gulf Spill Uncertainty and Fear Passing for Bolt Technology

BOLT reported strong 1st quarter figures and with the deepwater mess quieting down, the stock price has also bounced back up to previous levels. Absolutely nothing wrong with the company fundamentally.

No word of any acquisitions with the cash load BOLT possesses.

Still worth $13-$14 at a minimum. I’ll let time and Mr Market sort things out.

Disclosure

Long GRVY, MHH, BOLT.

Every investment has the potential to be both a great opportunity or a mistake.

How?

It all comes down to the price. Regardless of how bad or good you believe the company to be, the price will justify whether it is a good investment or a bad one.

There are too many instances where I dismiss opportunities because the state of the company is horrible. But do you ask yourself whether the current price justifies the situation of the company?

Risk by definition is the potential for permanent loss of capital. Therefore the price you pay will make up a great amount of that risk.

This brings me to previously held stocks.

For some strange reason, once I’ve bought and sold a stock, I find it difficult to buy back in. It’s like I dust my hands and take the stock off my mental list.

But I do maintain a list of stocks I previously owned that I wouldn’t mind owning again. Since I already know about the company, catching up on research is very easy, and the point is that old ideas can very easily become new ones.

So here’s my list of previous positions that I keep track of that may interest you.

Previous Stocks I Had Owned

Apple (AAPL) – Tech company.

Not much chance to buy at current prices. Although AAPL continues to redefine and lead the consumer tech age, I don’t follow the GARP (Growth at a Reasonable Price) strategy.

American Eagle (AEO) – Teenage retail.

Retail remains tough and the company still has a long way to go. From personal observations, it looks like their willingness to follow the fashion trend is on the slow side. Their 20-30’s concept brand Martin+Osa failed.

Atwood Oceanics (ATW) – Oil driller.

Not ATW directed, but I made a dumb mistake by not buying RIG (as well as BP). Other ideas worth watching in the oil drilling industry is ESV and HAWK.

Electronic Systems (ELST) – Wireless Products.

I bought ELST then realized I paid a little too  much. My initial calculations were incorrect, but drops to $0.35 is a buy for me. The low volume just makes it so difficult to get in and out.

Ambassadors Group (EPAX) – Educational travel programs.

My first spin-off purchase before I even knew what a spin-off was. The small niche it operates in makes it difficult to expand and garner growth. Trading around intrinsic value.

Entercom (ETM) - Radio

I have to admit a mistake here. I got scared out of buying again by the big drops. Recently dropped back to attractive levels but wasn’t able to pull the trigger. I have a lot to learn myself. Still able to generate plenty of FCF. Debt is always an issue but ETM has been one of the better ones in handling their debt load. The CEO of EMMS, the recent failed going private play, cites that the radio business is improving and he is seeing increased business in the industry.

Something to continue to keep an eye on and hope for another entry point.

EnviroStar (EVI) – Commercial drycleaning equipment.

For a company of its size, EVI is very profitable but the problem is that I see no catalyst. I don’t believe the CEO to be shareholder friendly and EVI isn’t in an industry with the opportunity to be bought out.

Will be taking EVI off the watchlist.

K-Swiss (KSWS) – Athletic Shoes.

KSWS hasn’t been able to recover as much from their lows. Concepts in Free Running didn’t pick things up as expected and they base sales off a few key customers who have reduced orders, making it tough for the company to pick up sales. Financial health is excellent though and management is shareholder friendly but don’t expect the stock to do much for an extra year or so.

NutriSystem (NTRI) – Diet food.

Company has been able to expand their distribution channel resulting in increased revenue but the current price does not offer an adequate margin of safety. I would like to see NTRI below $15 before revisting the company.

Radio One (ROIAK) – Radio

Price is below $1 again from $5. This one hurt bad. Held on far too long and a big reason for the under performance this year. It is tempting to see it at such a cheap price again, but the looming debt makes it risky. Unless it drops to the 50c range, risk is far too high despite the reward. Focusing on risk here rather than reward.

Servotronics (SVT) – Makes control components for machinery and cutlery.

Machinery equipment and cutlery don’t mix but SVT has been doing a good job of providing both. Strong balance sheet and a majority of sales coming from government contracts. No analyst coverage and tiny volume make it difficult to buy. However, price drops of 15% over a 1000 shares make the entry point possible at a cheap price. Looking for an entry point of around mid to low $8’s.

ValueVision (VVTV) – Home shopping.

I would say it was VVTV that made Old School Value famous

The sad thing is that the company hasn’t met my expectations of a turnaround. Their latest quarter was an improvement over the last comparable period, but the company is comparing itself to its worst year.

VVTV is now $2 but with the way it is currently running, I would say that’s about right. $1 is when I would buy again.

Disclosure

None