Investment Philosophy

In the first post, i touched on some principles by which i chose my investments. I figured it would make sense to formally outline some of the things i look for. Here it goes:

In the search for potential investments I look for companies with intrinsic value significantly higher than their current price. While intrinsic value is often in the eyes of the beholder, I try to look for companies where I can justify higher value with rather conservative operational assumptions. Companies that are going through tough period that depresses earnings and sales are usually perfect candidates if the issues bugging the stock can be comfortably described as temporary. I try not to assume any significant growth in revenues as part of calculating intrinsic value. Growth is often far from certain and the weight given to it in valuation is one of the main reasons value stocks have historically outperformed their growth counterparts. However if significant growth in revenues does occur in the underlying company, it represents a nice “icing on the cake” for the investment.

Some of the companies that I have invested in on the basis described above are: Lazare Kaplan International (AMEX: LKI), Corinthian Colleges (NasdaqNM: COCO), and Bradley Pharmaceuticals (NYSE: BDY).
Lazare Kaplan is an example of stock where downside is sufficiently protected by its assets. Its net working capital, if you include the usual mark-up on the inventory (a safe assumption given their commodity product), is about equal to its market value. Given that company’s margins have been squeezed due to increasing diamond rough prices, any improvement in their ability to pass on those prices to the customer would reflect very favorably in the price of a stock.
Corinthian, for profit educational company, has been hit by various bad news over the last couple of years. They have been under SEC investigation for bad debt accounting, sued by students for inability to transfer credits, and tried to expand to quickly which resulted in depressed margins. As all of the legal issues to date have been defeated and company stopped expanding and started concentrating on improving operations its stock should see significant upside in the next couple of years.
Bradley Pharmaceuticals is a company under investigation by the SEC for its revenue recognition practices. I performed the sensitivity analysis and realized at the time of investment (May 2005) that the market price assumes that quarter of firm’s revenues is doubtful. Based on the news it looked like that no more than 5-10% of firm’s revenues may be in question. Being comfortable that the discrepancy between two figures provides a significant margin of safety, I invested into the company and has been able to realize a 50% gain before a recent sale.

When possible, I also try to look at the companies that would be indirectly impacted by the events that are likely to happen. An example of such company is Maverick Tube Corp (NYSE: MVK). My investment in this company assumes that U.S. would have to start building refineries in a near future. Many articles mention lack of refining capacity as one of the drivers behind high oil prices. Maverick supplies pipers to the oil industry and is likely to benefit from increase in refining capacity. As it trades at less than 7x its last year’s earnings, I thought this would be a cheap way to capitalize on the likely upcoming events.