I can't tell you how often I stumble on seemingly compelling names that have been badly beaten up, then buy them and find that they stay that way long after what even I as a value investor can stand.
Fellow RealMoney columnist Bruce Kamich's technical-analysis piece yesterday on Callaway Golf (ELY) was a great reminder of such a stock. I wrongly perceived ELY as a compelling turnaround story several years ago, but sometimes it turns out that the market knows more than you do and an investment simply doesn't work out.
That's a tough lesson to learn -- especially as a value investor -- but it's important. There are times when you just need to move on. You can always come back to an investment if the situation changes.
Such has been my experience with Callaway, a former high-flyer that seemed a few years back to have many of the classic elements that make for a great turnaround. The well-known brand had a solid balance sheet until suffering from a liquidity crisis in 2009. That punished shares to the point where they were trading both below net current asset value and at less than two-thirds of tangible book value.
The crisis ultimately passed -- but Callaway has yet to regain its former glory. The company did more than $1.1 billion in sales in 2008, but it's been pretty much downhill from there. ELY shares, which topped out in the $35 range in 1997, have bounced between $5 and $10 for the past seven years.
New products and new management didn't work, while an expected turnaround for the golf industry failed to occur. I finally gave up after several years, took some marginal profits and rarely looked back until Kamich's piece caught my eye yesterday.
While I'm not yet convinced that Callaway is finally turning around, I have to admit that the company has been seeing some interesting developments.
For instance, revenue was actually up 5.2% last year, allowing Callaway to post its first annual profit since 2008. Granted, it wasn't a huge profit -- $16 million, for a 1.8% net margin. That's far below what ELY bottom-lined back in its glory days, but a profit is a profit.
On the other hand, ELY's stock float has grown by about 25 million shares since 2011, primarily as a result of a convertible-preferred-share issue that stemmed from the company's 2009 liquidity crisis. (Callaway also issued some convertible senior notes in 2012.)
As a result, tangible book value per share has fallen by more than 50% since 2010. I prefer to see share count decreasing, but I'll admit that ELY might have had to issue convertible shares (at least the preferred ones) just to survive. Survival trumps dilution, but that's still a significant jump in Callaway's shares outstanding.
The Bottom Line
Add it all up and I just don't see Callaway as a great value right now from a fundamental perspective. After all, the stock currently trades at 31x next year's consensus estimates, which seems rich to me. This is a company that I'd like to see turn around, but I'm not convinced that it will do so to a degree that justifies ELY's current price.
Of course, Callaway is still a great brand name and has an enterprise value under $900 million, so it might make a nice acquisition for someone under the right conditions. But that remains to be seen.
I'll admit that Kamich presented a compelling, bullish view of Callaway's chart from a technical point of view. He might be right -- but from a fundamental perspective, I'm just not convinced.