What's Intrinsic?

 | Aug 28, 2012 | 5:00 PM EDT
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I hear a lot of people talking about value investing but see very few actually practicing it these days. Once your asset base reaches a certain level, I believe that it is almost impossible to manage this style effectively. Therefore, I have been working diligently to further automate the research process. Yellow pads full of stock tickers and notes work fine for my current family-and-friends operation, but it looks like I will need to improve the process in the near future.

I have been torturing databases and spreadsheets for some days now in an effort to transfer the valuation information off the yellow pads and onto the computer. Although I am more a data troll than wizard, the process is coming along nicely. One of the four values I calculate for every stock is the intrinsic value of a company as a going concern. It serves as a measuring point for safe and cheap stocks and points to what a company will be worth if it does get the business back on track. It also has helped identify some growth oriented issues that are not asset heavy but nonetheless undervalued based on earnings strength and cash flow generation.

Some interesting ideas have popped up as I worked my through the data. After falling short of the always highly accurate analyst estimates, Cash America (CSH) has been falling for the past few months. In spite of this shortcoming, the pawn shop operator showed decent revenue and operating earnings growth in the quarter. In fact, as the economy has continued to struggle, its revenue rose by 18% compared to a year ago. Pawn shops and payday loans may not be the prettiest business, but the sad truth is that they are both necessary and profitable. The company has far too much goodwill on the books to ever be a tangible book value bargain, but it is a solid company that earns solid returns on equity and trades very cheaply when compared to its intrinsic value. At the current price, Cash America changes hands at about 72% of my ongoing concern valuation.

One stock to keep an eye on going into the election and through the end of the year is CACI International (CACI). The company sells software, simulations system as well as providing system integration services primarily to the U.S. government. The slowdown in government spending has slowed down the revenue growth rate and concerns about the year-end fiscal cliff have also weighed on the stock price. The company has several projects that the Department of Defense view as high priority. So even if spending on the projects is delayed, CACI will eventually benefit. If spending sequestration becomes a fact in 2013, this stock will likely get punished along with other government contractors. This could create a bargain situation worth exploiting for long-term investors. Right now, the stock trades at about 72% of my estimate intrinsic value.

Some of my old favorites still show up as intrinsic value bargains. Fly Leasing (FLY) has been a fantastic stock for me the past several years. The aircraft leasing company has done a masterful job of managing the business and the balance sheet. Not only does the stock trade for 70% of tangible book value, it is currently fetching only half its intrinsic value as an ongoing business. Revenue growth has averaged over 30% annually for the past five years and its portfolio lease rate remains among the highest in the industry. With a generous 6.9% dividend, this is a stock I hope to own forever because its book and intrinsic value continue to grow faster than the stock price.

American National Insurance (ANAT) has not done as well as the stock price is basically unchanged over the past couple of years. However the stock trades at half of both tangible book value and my intrinsic value calculation.  The stock is too cheap not to own at this level and yields more than 4% at today's price. Apparently, I am not the only one who is comfortable owing the stock until conditions improve. The list of investors includes such value luminaries as Tweedy Browne, Donald Smith and Company and Royce Funds among others.

Intrinsic value is just one of the four calculations I use to value a company. My primary valuation tool is tangible book value and always will be. However, the IV calculation is a useful guide to determining what a company is worth as an ongoing business and it can help uncover  bargain issues that are not asset intensive.



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