When deep value gives way to momentum, the results can be lights-out. Identifying value names that most other investors don't want to own, where there is typically little analyst coverage can be lucrative in and of itself. But often those of us who fish within that pond are long gone by the time the growth and momentum crowd re-engages.
At times this has been frustrating; you buy what you believe to be an undervalued name, it doubles, triples, or otherwise hits a level where you believe it is fully valued, and you sell and re-invest the proceeds elsewhere. Meanwhile, the stock is pushed higher by a different crop of investors, and you've left a lot on the table, perhaps a great deal more than the gain you locked in.
It comes with the territory, and it is difficult to sacrifice investment principles, in hopes of achieving higher gains. This means that you don't get emotionally attached to a name and you don't look back when it reaches full valuation, which, of course, is in the eye of the beholder.
Electro Scientific Industries (ESIO) may be a great example of a former deep-value name that has become a momentum play. Last year, it was one of the members of my 2017 Double Net Value Portfolio. It was a $6 stock that was no longer profitable, and seemingly off the radar of most investors. The company happened to have a clean balance sheet, no debt and ample cash, which can be fairly typical of double nets. The company just needed a catalyst, in this case to turn around falling sales, and get back to profitability.
After languishing for much of the first half of 2017, first-quarter revenue (July) jumped dramatically, and the company handily beat estimates. That was followed by another better-than-expected quarter for two consecutive solidly profitable quarters, and the stock was off to the races. In fact, it was the top performer in my Double Net Value Portfolio, up 267%, and a major reason that the portfolio performed much better than its benchmarks.
Rising valuations, however, pulled ESIO out of contention for my 2018 Double Net Value Portfolio, but the name continues to roll. Yesterday after the market close, ESIO reported solid preliminary third-quarter results, with revenue expected to be in the $106 million - $111 million range, well ahead of the $85 million consensus, and earnings per share also ahead of the $0.55 consensus estimate, although the company did not get more specific. This has the earmarks of a blowout quarter, and the shares are up 21% Thursday morning, which would put ESIO shares up around 25% year to date.
It appears as though ESIO is moving out of the value realm, although we have not seen the balance sheet for Q3, nor do we know what guidance really looks like for next year.
In any event, this has been a fantastic turnaround story, but not one that will benefit the 2018 Double Net Value Portfolio. ESIO has grown up, and moved on.
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