Check Your Emotions

 | Apr 10, 2013 | 1:00 PM EDT  | Comments
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Stock quotes in this article:

ceco

,

iqnt

,

tlab

I am going to continue looking at stocks produced by a mechanical-value investing system. I'm fascinated by this approach and plan to dedicate more research and effort to it. It removes emotions and second-guessing from the process, and the early results are promising. My programming and data skills are sadly lacking but I believe I can torture the data long enough to see how well this works over time. As a bonus, this approach helps identify cheap stocks I might have otherwise overlooked.

One of the benefits of a mechanical system is that it overrides the human element and buys stocks I would have avoided. This is certainly the case with shares of Career Education (CECO). Although I never shorted this particular stock, I have been betting against the education stocks for about three years and I am still not excited about the industry. But this stock is super cheap at 30% of tangible book value and management is attempting to right the ship amid the storm. The company is closing campuses and cutting jobs, which should save about $50 million a year. That is about a third of what it lost last year, so the business will have to get better for the stock to recover. The for-profit education business in the U.S. will continue to decline but this company is seeing growth in its international schools. The system doesn't address profit or potential, yet the stock qualifies -- so into the portfolio it goes.

The same "probably not" characteristics apply to at least two other stocks in the portfolio. I have made money with Imation (IMN) in the past as it has been a perennial net-net and book-value stock. As cheap as the shares are at 60% of tangible book value, the business is terrible and the company is selling the audio and video accessories business. The tape-storage business is in decline and the company's attempts to enter the data security and mobile storage markets are going to be an uphill climb. But it qualifies, so into the portfolio it goes.

Neutral Tandem (IQNT) would not have made it into my discretionary portfolio either because I tend to avoid network-services companies, a fiercely competitive field that I do not understand that well. But they provide Internet Protocol (IP) transfer services and I am told that is a promising market. Neutral Tandem has 120 Ethernet hubs on four continents and does business in 80 countries. A large customer just revised its contract for voice services at much lower rates and that is going to pressure sales and profits this year. Analysts seem to expect the data business to improve next year and see the new EtherCloud connection product gaining greater acceptance. The company has no long-term debt and the shares are trading hands at 50% of tangible book value, so we are mechanical buyers of the stock.

Tellabs (TLAB) is a stock I have owned for some time and often suspect I will own forever as the company has struggled to remain profitable, much less grow. Its relationship with AT&T (T) for its telecommunications, voice and data equipment has diminished over the past few years and the European markets will be slow for several more quarters at least. The stock rallied a bit last year when the company paid a special $1 a share dividend, but the operating results have caused steady selling since the beginning of 2013. As is the case with many cheap stocks, there is nothing going on except the valuation itself. The stock trades at 70% of tangible book value, has no debt and trades for a little less than the cash per share on the balance sheet. I own it and so does our mechanical value portfolio.

I would not say that I am ready to turn my whole business over to a mechanical value-investing approach, but I do find it interesting and suspect the research effort will prove to be valuable. In my next column, I'll review some of the stocks that the mechanical approach and I agree on for most long-term, asset-based value portfolios.

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