Weekend Values – February 27, 2011

Posted February 27th, 2011. Filed under Investing Links

As usual, a few of the best value investing links from the past two weeks:

Sears Holding Corp (SHLD)

Long. Sears is a company with a long brand history that has gone through its share of well known struggles over the past few years.

The stock, a holding company for the 2004 merger of Sears and Kmart, is headed by well-known financier Eddie Lampert of ESL Investments.

Other well-known long-term investors such as Bruce Berkowitz and the Tisch Family (of Loew’s fame) have a large stake as well. While the core business is struggling, the company is backed up billions of dollars of real-estate and other favorable assets, protecting the down-side.

While the stock has run-up since the original analysis, it is a great example of a sum-of-parts breakdown for a complicated company.

ITT Corp (ITT)

Work-out. Another conglomerate, ITT announced a split of the company into three operating businesses: Defense, Water, and Industrial Products.

Spin-offs have been proven to a profitable source of investment ideas, and the article does a great job of breaking down the individual business segments.

Rolling up the respective valuations into the core holding company doesn’t leave much margin of safety, but the new entities could be prime candidates for value investors.

I will be keeping a close eye industrial products segment, especially since the ‘new ITT’ is not as fancy as the other two divisions. This dynamic could lead to forced selling and a resulting attractive price.

Citigroup (C)

Long. After suffering through the financial crisis (including a government rescue and massive dilution for existing shareholders), Citigroup is now trying to move forward with a more conservative strategy and better risk management.

While outside of my circle of competence, there is no doubt that Citigroup has enormous global potential with operations in over 140 countries. Most of the toxic assets were spun-off into the Citi Holdings subsidiary, and the new bank is trying to stick to its core vanilla banking.

Using several optimistic assumptions (rise in ROA, positive valuation of Citi Holdings and tax assets) yields $0.80 EPS in 2014, or only 5.5x the current price.

While I normally like to look at historical earning power and not pay-up for growth, it is a compelling argument that is backed up other well-known value investors including John Paulson, Bill Ackman of Pershing Square, Bruce Berkowitz of Fairholme Capital, and David Tepper of Appaloosa Management, among others.

TravelZoo (TZOO)

Long. As a deep value investor, TZOO is normally a stock I would avoid: it trades at 50x TTM earnings. But with all of the media attention around the phenomenal success of Groupon, TZOO seems to be positioned to compete in a very hot space.

The write-up breaks out the business into its core travel deals segment along with its new entry into the local deals business.

Assigning a $300m valuation to the core business and $335m valuation to the local deals business results in a fair valuation of $635m on 2011 numbers. With a market-cap of $700m, the business seems fairly valued.

However, a thought-provoking quote sums up the investment thesis:

“Of course, we want to skate to where the puck will be and not where the puck has been or to put it in another way, this is a case of buying a great company at a reasonable price based on conservative assumptions.”

If those assumptions play out, it might turn out to be a great investment.

Paradise (PARF.PK)

Long. In my recent journey through the Pink Sheets, PARF was a stock that caught my eye due to a large discount to both book value and NCAV. In addition, the company dominates its core niche – believe it or not, the candied fruit business!

However, despite the significant asset base, the business has struggled with low operating margins and ROE over the past several years. The article outlines several avenues for improvement, but it is still unclear whether management has taken those necessary steps.

For those interested in net-nets, it could be a stock to watch.


If you have links or suggestions to detailed analysis from other value investors, please drop me a line using the Contact Form.

I’m always open to ideas from other investors, especially for a thoughtful and well-researched investment articles.


No positions.

Iteris Inc (ITI) – Q3 2011 Earnings Update

Posted February 24th, 2011. Filed under Holdings Stock Updates

Iteris Inc (ITI) reported fiscal third quarter earnings last week.

Although product sales were up 16%, the company was forced to report a large goodwill impairment charge in its Transportation Systems segment.

The stock dropped sharply on the news, but has since rebounded.

Earnings Highlights

Overall, revenue for the quarter was up 3.4% to $14m, compared to $13.6m in the same quarter last year.

The increase was primarily due to a 16% hike in product sales (with both Roadway Sensors and Vehicle Sensors showing double-digit growth rates) offset by a decline in Transportation Systems revenue of 12.2%.

Despite the top-line increase in the Vehicle Sensors division, ITI still reported a small loss in the segment.

The Roadway Sensors segment commands the highest margins so continued sales increases will help overall profitability and cash flow.

In my analysis of 2nd quarter earnings, I mentioned that a major risk was goodwill impairment in the Transportation Systems division. Those fears came true in the third quarter, with the company taking an $8m impairment charge.

According to management, the charge

“does not impact in any way our bullish long-term view for the business segment”

The impairment charge makes earnings comparisons difficult, with the company officially reporting a loss of $7m, or $0.20 per share.

Excluding the impairment charge and other non-cash items, Iteris would have reported earnings of $0.01 per share, compared to $0.02 per share in 2009.

The company still reported positive free cash flow for the quarter, and added to its cash balance – net cash sits at $9m.


In December, Iteris announced the acquisition of Meridian Environmental Technology, Inc (MET), a leader in 511 advanced traveler information systems. MET has been around for 17 years and is a growing business in an important niche.

The purchase price was approx. $4m in cash, plus another $2m based on an 24-month earn-out provision.

The companies have worked together on projects in the past. The new combination is now one of the top 1 or 2 providers in the U.S.

The good news is that management expects the acquisition to be immediately accretive, to the tune of $1m in revenue plus positive operating income in the upcoming quarter.

Conference Call Notes

Transportation Systems

– Just sent out a $10m design and build proposal to a state agency

– Making additional investments in sales & marketing ; new office in Abu Dhabi

– Federal Highway Bill – a key piece of transportation legislation – is expected to be brought before Congress sometime in the next 6-9 months. ITI expects funding for transportation technology to be significantly higher in the new bill

Vehicle Sensors

– EU is mandating safety features (like LDW) for new commercial trucks by 2013

– Joint announcement & go-to-market strategy with Audiovox for Advanced Driver Assistance System. Over 200 media people in attendance. ITI handled design but VOXX is doing all manufacturing and marketing. Lots of growth potential

Roadway Sensors

– 25% of sales in past two years has been from new products

– Continued push into both domestic and international markets


While the impairment charge put a damper on the earnings release, management seemed extremely bullish on the conference call.

In the past 3 years, free cash flow has averaged $6.1m, a number that the company should approach for fiscal 2011 as well. That would translate into an EV/FCF of only 7.8x, leaving plenty of room for improvement.

Lloyd Miller, a noted microcap investor and large holder of ITI, made a huge purchase on the initial drop after earnings, a positive sign.

This quarter is traditionally the slowest of the year, and management expects improvements in both the top and bottom line for the upcoming quarter.

I think the long-term trends in this business remain extremely strong, especially with the recent acquisition, new product lines / partnerships, and the upcoming Transportation Bill.


Long ITI

As I had mentioned in my previous posts on the evolution of my value investment philosophy, I’ve recently been focusing more on microcap stocks trading on the OTCBB and Pink Sheets.

While many stock screeners aggregate data for most stocks on the OTCBB, Pink Sheets are not required by law to file periodic financial statements, making a screener less useful.

Despite this, many Pink Sheets continue to file audited financial statements and press releases.

Since many investors are unwilling to purchase these types of securities, this dynamic presents a great opportunity for the willing investor, as many of the securities are significantly mis-priced.

Buffett’s Approach

At the 2001 Berkshire shareholder meeting, Buffett talked about his approach to investment research:

When I started, I went through the manuals page by page. I went through 20,000 pages in the Moody’s industrial, transportation, banks and finance manuals — twice. I actually looked at every business — although I didn’t look very hard at some.

Since the opportunities in the broader market are drying up (at least for the fundamentally cheap stocks I’m looking for), I used this as inspiration to start my own research project into all of the businesses trading on the Pink Sheets.

I would look at every possible stock and decide whether it was worth further research.

As Buffett said, I wouldn’t look very hard at the majority of the available stocks, but I was hopeful that I would find a few gems.

On the OTCMarkets website – the go-to source for Pink Sheets securities – I started with the Symbol Information File for the entire company directory.

A recent check shows 20,730 individual securities, a staggering number.

Research Methodology

A significant number of these securities consist of stocks trading on the Grey Market – a security that “is not listed, traded or quoted on any U.S. stock exchange or the OTC Markets” and has no market maker – and therefore can be avoided.

Check out the list of OTC Market tiers to better understand the various levels of disclosure.

I also removed international stocks, setting them aside for further review later. (Right now, I continue to trade through Zecco, which does not provide exposure to international markets)

For the initial stage of this project, the focus was on U.S. common stocks.

Once the list was cut down, I started going through the list one-by-one.

I’d open up each stock quote page on OTCMarket and check out the latest price quote, stock chart, and company information. I’d look at the financials, and open up the latest 10-Q and 10-K.

I could usually tell within a minute or two whether the stock warranted further analysis.

Many stocks are labeled as development or exploration companies, outside of my circle of competence and likely not generating revenues.

A large portion were banks and other financial institutions, an immediate pass for me.

Others were shell companies, continuing their public disclosure in the hopes of merging with an entity in the future.

And numerous others had no identifiable business model or updated financial information.

Consistently negative profits, tons of debt, recent or repeated share dilution (a favorite among the penny stocks) are all reasons to cross the name off of the list.

The ugliest had literally billions of shares outstanding yet traded for only fractions of a penny.

While some investors might find value in these types of securities, I decided to just pass instead of looking at them very hard.

At the same time, many of the stocks were growing, profitable businesses with long histories, but ones that had decided that the costs and compliance of Sarbanes-Oxley and full SEC reporting were not in the best interest of the company or shareholders.

If the stock passed the initial once-over, I’d usually spend time reading the full annual report, the last few quarterly filings, as well as the proxy statement and any recent press releases or insider filings.

Only then, satisfied that it was a legitimate, worthwhile business, would I add it to the watch list for full due diligence at a later date.

By the Numbers – 3698 Stocks Later

Pink Sheets Stock Chart

Final Tally: 3,698 stocks

Roughly 15% of the stocks passed my initial 2 minute due diligence check.

Of the stocks requiring further due diligence, I broke them out into subjective tiers based on their overall business model, cheapness, insider holdings, etc.

Pink Sheets Interesting Stocks Breakdown

All Tier 1 stocks required additional due diligence and number crunching to identify actual investment candidates.

To date, maybe 20-30 companies made it as candidates on my immediate watch (or buy) list.

30 out of 3698



There is no doubt that there are still incredible bargains out there for investors who are willing to put in the effort to comb through the undiscovered corners of the market.

A few examples:

  • A business with 50 years of history trading at 1.5x EV/EBIT & less than working capital
  • A sub $50m stock that grew revenues through 2008/2009 with an average FCF yield of 27%
  • A $300m in sales company selling for 0.65x book value, with positive net income for 9 out of 10 years

It was an incredible exercise, and definitely helped my confidence in evaluating companies through their financial statements alone.

In these stocks, the simple things matter – profits, cash flow, positive equity – and I’ve found that I prefer it that way.

It took me almost 2 months to complete this initial review, but it is a quest that never ends. I need to go back through the Tier 2 & 3 stocks for a second pass.

Final Thoughts

In a 1993 interview, Buffett talked again about his recommendation for investors who are starting out with small sums of capital and searching for undervalued opportunities.

Adam Smith: If a younger Warren Buffett were coming into the investment field today, what areas would you tell him to point himself in?

Warren Buffett: Well, if he were doing – if he were coming in and working with small sums of capital I’d tell him to do exactly what I did 40-odd years ago, which is to learn about every company in the United States that has publicly traded securities and that bank of knowledge will do him or her terrific good over time.

Smith: But there’s 27,000 public companies.

Buffett: Well, start with the A’s.

3,698 stocks later.

From A – Z.