For most companies, both income gains and income losses are attenuated to a large extent by taxes. In this regard, the government acts as a business partner, reducing the risk of loss in any one period (as long as offsetting gains were achieved in the recent past or can be achieved in the future!), but also sharing in the gains. But in certain situations, investors can sometimes stumble upon companies that do not have to share such gains.
Consider Key Tronic (KTCC), a designer and manufacturer of keyboards and other computer input devices. Over the last 8 years (including this one), Key Tronic has been profitable, as it has garnered business from original equipment manufacturers participating in a trend towards low-cost outsourcing. But Key Tronic has barely paid any taxes over that period. In fact, due to a storied past, Key Tronic has net operating loss carryforwards (i.e. losses that can be applied to future income for the purposes of calculating taxes) of over $40 million. The company's market cap is only half of that, as it earned about $1.5 million this year!
Some of these carryforwards expire every year, but management believes it will be able to apply most of those losses, reducing the company's tax rate considerably. For many companies, every dollar of operating income translates to about 65 cents of income. For this company, each dollar of operating income translates directly into a dollar of income, representing a 50% bonus to shareholders! Such future benefits should have the company trading at a premium to its peers, yet this company trades at a discount to its net current assets.
By going beyond a company's headlines and by reading the notes behind a company's financial statements, investors put themselves in a position to find value that would otherwise go uncovered. Tax-loss carryforwards represent just one of the many useful items investors can find in the notes to the financial statements.
Disclosure: Author has a long position in shares of KTCC
This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.
