Take The Hint

In the current climate, there is no shortage of potential value investments. Unfortunately, certain managements are eroding that value, rather than passing it on to shareholders. Recent examples of that appear to be taking place here and here.

At the same time, there are other potential value plays where it's a little less clear as to whether value will be eroded or whether it will eventually accrue to shareholders. In these companies, management may be doing a little bit in order to appease shareholders, but could be doing a heck of a lot more. Examples of this type of company are discussed here and here.

Finally, there are the value plays where management doesn't just talk a big game...they deliver. These managements have a history of making great capital allocation decisions, resulting in a business with strong returns on capital, and a record of returning cash to shareholders when investment opportunities aren't there. Usually, such companies trade at expensive prices, but in an environment such as this one, where fear rules the day, stocks in such companies are available at very attractive prices.

Management teams in this latter category make it so that shareholders don't have to spend a lot of time trying to understand and interpret management's actions; instead, the only hard part for shareholders is valuing the companies accurately enough to determine whether they are cheap enough to buy.

Some of these shareholder-friendly companies even act as value investors, as they adjust their capital allocation decisions based on the company's share price, taking advantage of the opportunities Mr. Market offers. For example, both Cisco and Best Buy, which are just two examples of such companies, have been furiously buying up shares. Furthermore, they've hinted to investors that this will continue at current prices.

"[I]f overall market conditions continue to be depressed, you could expect us to be more opportunistic in our repurchase program, especially at these levels", according to Cisco's CFO.

Best Buy's CEO said last month that he "believe[s] our share price is such that we're undervalued in the market and we think over time that's the best investment [of capital]."

At the rate at which these two example companies are buying up shares, today's investor will own these entire companies outright in about 5 years unless the share prices rise. (Of course, I'm not selling at these prices, so you and I would become partners as owners in these companies. Hopefully, we get along.)

Realistically, however, you're not going to become a billionaire in just five years. What will likely happen in the interim is that the share prices of these (and other similarly cheaply-priced) companies will rise such that the firms will no longer get so much bang for their repurchasing buck. But that's not a bad scenario for investors either.

Incredibly, these companies are not depleting their balance sheets in making such large repurchases; they are simply trading at such extremely low earnings and cash flow multiples that they can afford to buy back almost 20% of their outstanding shares annually using cash flow from operations.

We've seen many examples in the past where stocks trading at low multiples have seen dramatic increases in price when management has committed to making capital allocation decisions in the best interests of shareholders. Recent examples can be found here, here and here. The current macroeconomic turmoil is once again providing opportunities to investors to seek out and profit from such businesses.

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please consider subscribing to the site's RSS feed.