Archive for the ‘Green Investing’ Category

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Mead Instruments Corp.

Thursday, September 2nd, 2010

We believe that the value investing style is frequently overlooked by Green, Clean and Socially Responsible Investors.   Meade Instruments Corp. the manufacturer of telescopes and telescopic products could be classified as a Clean Investment with negligible environmental impact.

Meade Instruments Corp (symbol: MEAD) is a classic Benjamin Graham Net Net stock which we are long in equity portfolios.   Meade is a manufacturer of telescopes and telescopic instruments, with hardly a taint of excitement or sex appeal.  Meade is your typical boring, mundane, blase…well you get the picture, its a boring company in a boring industry.

Unless you’re a financial geek in search of Margin of Safety stocks where looking at the company’s balance sheet Net Current Asset Value (NCAV) is larger than the valuation of Meade’s market value by a sizable amount.

As of 9/2/2010 Meade shares are trading at $3.24 a share.   They have 1.17 million shares outstanding and the total market cap is a nano-sized $3.79 million dollars.

Cash on hand amounts to $3.33 a share, which is a drop of $1.2 million from last year due to losses in the company’s operations.

Inventory amounts to $6.72 a share

Book Value $10.18 a share

Current Assets $12.27 minus Current Liabilities $3.42 = $8.85 a share

At present Meade is losing money and the cash drain might tap out current cash levels in one to two years, assuming no reduction to inventory levels which could be converted to cash.  The company is faced with increasing foreign competition resulting in lower sales, reduced distribution outlets and the reality of being the manufacturer of a discretionary item in a weak domestic economy.   Higher end and more profitable telescopes are less favored by consumers nowadays than lower end, lower margin scopes.

To compensate Meade is cutting costs on many levels ranging from administration and employment costs, reduction to R&D and reducing manufacturing costs.  In addition, Meade has sold three divisions: Simmons, Weaver and Redfield for gross proceeds for approximately $15 million.

It would be hard to make a valid rationale for the purchase of shares from a growth perspective since there is no growth, quite the opposite in fact.   Meade is facing the reality that the manufacture of telescopes with competition from lower cost manufacturers in China is likely going to be a losing proposition.

The investment appeal:  Management has a great deal of incentive to at least preserve the value of the company and its shares.   Management owns approximately 36% of the shares.  Based on the latest SEC filings Hummingbird Capital (a private small stock value oriented hedge fund) Paul Sorkin owns at least another 10% of MEAD shares.  There are a few other value managers who might take an activist role who’ve purchased shares.

My belief is the company is preparing itself for the potential of being sold.  The disparity between the share price and current cash + inventory of $10 a share is much too great a gap.    The majority of shareholders have a great incentive to close the gap, preserve the Meade brand name and allow it to operate as a division of a larger company.

Estimates to the potential sale price might largely depend on the value given to their sizable inventory of $6.72 a share.   If we were to reduce the value of inventory to half or $3.35 a share then add back the current cash of $3.33 we arrive at $6.68 which could be a conservative estimate.   The aggressive estimate would likely be closer to the current book value of $10.18.

This is a risky stock and shares are thinly traded.   The company may choose to nothing which would drain their cash reserves and further reduce book value.   The company could sell off its entire operations and convert to an all cash company and reinvent itself.  Time will tell but I do feel the rewards could be in the range of 100% to 200%.

Be careful out there

Brad

Long MEAD

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Should a Socially Responsible Investor Invest Heavily In Bonds Now?

Wednesday, September 1st, 2010

Green and SRI investors along with investing professionals are always asked to make the best decisions under pressure, and the most common one we face today is should “Socially Responsible Investors abandon stocks in favor of bonds?”

It is my opinion based on close to thirty years of trading that the best trades are those done when you’re in the minority not the majority opinion, otherwise who’s left to buy or sell?

For this question of stocks sold off in favor of bonds, bad news has to be considered good news.    Any good news on the economy will be treated negatively at this point in time for bonds.   Today’s stock market strength and weakness in bonds is due to the better than expected August PMI report which came in at 56.3 versus the consensus of 52.9 and the August report is an improvement upon July’s 55.3.   Adding fuel to the rally is survey from Investors Intelligence which shows that just 29% of newsletter writers are bullish which is the lowest percentage since the crash in 2008.   Remember folks, the more extreme the consensus the greater chance of a reversal in market direction.   A bull figure at just 29% might be enough to halt the decline at worst…..but its certainly in the range to mark the bottom where a new rally can emerge.

Good news is bad news for bonds.  The 10 year Treasury has moved from 2.48% to 2.6% today while the 30 Year Treasury Bond has moved from 3.53% to 3.68%.  Bond yields are now at levels seen in late 2008 and very early 2009 and we all know how productive it was to buy bonds in February of 2009.

The stampede into bonds has been nothing short of epic and the Consensus Survey of bond investors maxed out at approximately 80% recently.   Rarely has such a consensus opinion been profitable.   These are the kinds of surveys we frequently see at major market tops which begs to ask whether bonds are in a Bubble.    Bubble talk has been pervasive in the media much just as talk of Deflation has been over commented upon.

Frankly there’s more contradictory information and confusion in the media to rival a Republican politician who wants to reduce the deficit while maintaining tax cuts.  The bottom line is we do not have Deflation in the U.S. at present as Deflation is a very rare event here.

But are bonds really in a Bubble?   My answer would be “not at present”.  My definition of Bubble for the any investor including the Green Investor or the Socially Responsible Investing community is that for a Bubble to truly exist the risk of a significant and permanent loss of capital must be present.   A Treasury bond will eventually pay off at par upon maturity, so while its very possible to lose 20% or more in a bond, the loss would be temporary if you were patient enough to wait till maturity.  The reality is only a very few investors have that kind of patience.   In addition, many of the investors who are retirees and have been buying Treasuries will not be around in time for their bonds to mature, so a loss could be taken.

With Consensus opinions at present in the range of 70% to 80% Bullish on Bond prices, should the tone of economic data change (I believe its starting to happen now) the rush to exit bonds could be swift and very dramatic, especially in this day of algorithmic and program trading.

A by product of the rise in bond prices and drop in yield is the relative valuation of bonds to stocks.


As the chart above highlights, the relative valuation of bonds to stocks is at extreme levels and the other two times in the past century this relationship was reached, buying bonds in lieu of equities was a significant mistake.   Can we say that in the two past examples that bond investors lost money?  No, not unless they held to maturity but they lost “opportunity” to be in equities as the mean relationship between stocks and bonds eventually asserted itself once more.

We’re faced with the challenge of “getting back to pre-crash levels” and by over allocating to bonds now is essentially giving up that goal at time when the odds are stacked against you.

To be a successful Green or Socially Responsible Investor sometimes means enduring pain and the pressure of the media, not to mention friends who offer their opinions in an effort to “help”.   Diversification between bonds and equities is always a good thing and proper re-balancing when one asset class becomes overvalued is essential, but to join the mass entrance into bonds at this stage may very well lead to a mass exit when the weak patch of our economy passes and moderate growth re-emerges.

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Utilizing Investor Sentiment for the Green Investor

Thursday, August 26th, 2010

Too few individual investors how to use Investor Sentiment to their advantage.    Last week when the New York Times ran a front page story regarding individual investors fleeing equity mutual funds in favor of bond mutual funds, it should have made any long term Socially Responsible Investor giddy with glee.

Why?

Extreme negative sentiment as depicted in the NY Times should be used as an inverse barometer of when to invest.  However, more often group think sets in and investor is intimidated by being the lone wolf buying shares while the herd is stampeding in the other direction.

Right now, sentiment as expressed by the American Association of Individual Investors is getting extremely negative….and thats a good thing.   Who’s left to sell when only 21% of members polled are positive on the markets?  21% happens to be one of the lowest polls recorded in the past 15 years.   You may be right in your views of why you want to sell…….but, and this is the tricky part that the majority of investors never learn to master:  You may be right in your thesis but if you’re in the majority with your views, chances are your opinions have already been absorbed by the markets.

Using data supplied by www.sentimentrader.com:

Since 1987, there have been 47 instances where AAII sentiment fell to 21% or below.  The results are:

3 months later: the average return was 5.8% for the S&P 500 with 98% of the 47 instances positive.

6 months later: the average return was 10.9% for the S&P 500 with 91% of the 47 instances positive.

In conclusion, many investors think they can manage their assets completely on their own but unfortunately do not know how to interpret sentiment data.  Going against the herd is never easy but you must be able to master your emotions in order to be a successful investor, otherwise you might consider hiring an adviser who’s weathered a great many storms in their career.


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The Bounty of the Balance Sheet

Monday, August 16th, 2010

With the economy fluctuating between a glass half full one week and bone dry the next we continue to focus on Value and special situations based upon our equity model.  For all practical purposes its impossible to predict where the economy will be in a year, but we do know that this period in our history corporations have rock solid with frequent over capitalized balance sheets (lots of cash, little debt) while the consumer continues to de-leverage from decades of over consumption (which will take years).

Value continues to be exploited in the markets as one of our long term holdings Sports Supply Group has been acquired by private equity firm ONCAP LP,  shareholders will be receiving cash in lieu of stock.  This marks the third holding of ours in 2010 that has either been acquired, subject of a hostile takeover or considering sale of the company.   Asset rich companies make attractive targets since the cash on the books is quantifiable and frequently the underlying business can be acquired for little or nothing.  Frequently these companies are the targets for Value investors who love nothing more than predictable and boring companies in sleepy industries with hairless balance sheets.

Present market weakness has pressured the price of Audiovox symbol VOXX to an excellent entry point here at $6.55.  VOXX has approximately $330 million in current assets and $118 million in total liabilities which net to $212 million but the market value is $148 million.   The $64 million dollar difference with 18.5 million shares outstanding or $3.45 per share is a rock solid Margin of Safety to the patient investor willing to wait for the value to move in excess of the balance sheet.  The stock holds the potential for a 50% or more rate of return assuming the balance sheet remains intact.

VOXX has been around since 1965 and makes some of the coolest audio equipment in the world but it isn’t always profitable.  Earning expectations for 2010 are in the .35 per share range but the estimate is from only one analyst.

Products are marketed under the Audiovox brand name along with other brands such as Acoustic Research, Advent, RCA, Jenson, Road Gear and Spikemaster.

One aspect that caught our eye was the list of investors who own significant stakes in VOXX:  Seth Klarman of Baupost Group, George Soros and Irving Kahn.

We expect owning shares of VOXX to be a long term investment, investors should have a multiyear expectation.   It is the type of stock that you could rest easy when you go on that multi-year sabbatical to the Amazon.

Others may want to wring their hands with the potential for deflation, however with investor angst so high at the moment reflects that much of the deflation debate may be baked in the cake of the market for the interim, hence the potential for significant values is quite good.

Be careful out there.

Brad Pappas

Long VOXX

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Alternative factors to consider in evaluating Socially Responsible Investment performance

Tuesday, July 27th, 2010

As an investment manager with Rocky Mountain Humane Investing (www.greeninvestment.com)  the most common question we hear from potential clients is “and advisor told me that socially responsible investing isn’t profitable” versus unscreened portfolio management.   In general the advisor providing the dogmatic opinion does not offer any foundation for their opinion but this is their chance to influence the potential client especially if they cannot offer an SRI option for the investor.   Unless you have a few arrows of your own in your quiver you may be quite likely shrug your shoulders and resign yourself to an unscreened portfolio versus a clean portfolio.

Probably due to the fact that I’m over 50 now with a repellent view of hyperbole and unsubstantiated opinions I have been uncomfortable with opposite view as well: socially responsible investing improves rate of return.  It has been my view based upon empirical experience of managing SRI portfolios for 20 years that SRI is not a significant determinant of investment performance.   SRI is a highly subjective practice where investors can have divergent opinions on industries and companies.   There is not unified screening standard amongst the SRI industry, each firm or fund makes their own decisions on screening criteria.  While some funds screen for only 3 or 4 issues there are other funds that screen over a dozen.

Practitioners of SRI may draw attention that investors always assume a given level of risk with any equity investment but that the risk premium associated with SRI is less.    Case in point the risks associated with Tobacco, Asbestos or BP and the Gulf oil disaster.  However in my 20 years involved with socially responsible investing, screening stringency is often a matter of interpretation as BP was considered Best of the Lot for many years for funds that desired petrochemical exposure.

Let’s take a look at some of the academic studies that have touched upon the issue of the factors of SRI performance:

  • Moskowitz Award winner, John Guerard, Jr., director of quantitative research at Vantage Global Advisors, examined the returns of Vantage’s 1,300 stock unscreened stock universe  and a 950 screened universe (The screens eliminated companies that failed to pass alcohol, gambling, tobacco, environmental, military, and nuclear power). He found “that there is no significant difference between the average monthly returns of the screened and unscreened universes during the 1987-1994 period.  The “unscreened 1,300 stock universe produced a 1.068 percent average monthly return during the January 1987-December 1994 period, such that a $1.00 investment grew to $2.77. A corresponding investment in the socially-screened universe would have grown to $2.74, representing a 1.057 percent average monthly return. There is no statistically significant difference in the respective returns series, and more important, there is no economically meaningful difference in the return differential.”

Guerard’s conclusions are reinforced by other works:

  • “Socially Responsible Investment: Is it profitable” Dhrymes, Columbia University July 1997 June 1998.Dyrymes concluded that: “that by and large the Concerns and Strengths of the KLD index of social responsibility are not consistently significant in determining annual rates of return.”

  • Socially Responsible Investment Screening Strong Empirical Evidence For Actively Managed Value Portfolios.  June 2001, revised December 2001 Stone, Guerard, Gultekin, Adams.“No Significant Cost” means no statistically significant difference in risk adjusted return”. In addition, they surmise that “the conclusion of no significant cost/benefit is not just a long term average.  It has remarkable short term consistency!”

In my opinion this report presents a balanced view in that they concluded that the during the time of the study 1984-1997 the stock market rewarded the growth oriented style and that the performance of SRI investments could become “brittle” if markets were to become risk averse and adopt a more Value oriented style……….a remarkably accurate presumption!

Could the performance of SRI funds which have exceeded or lagged their respective benchmarks be in part due to size (average capitalization from micro cap to large cap) and style (Value or Growth)?

Fama and French of Dartmouth University examined the annual rate of return and beta (volatility) of an unscreened universe of Growth vs. Value from 1928 to 2009 by dividing stocks into ten deciles (groups) based on book-to-market value, rebalanced annually and found that Value had the lower risk while Growth had the higher risk.  In addition, they found that the highest book –to-market stocks exceeded the return of the lowest book-to-market by 21% to 8% on average.   Stock valuation was as significant factor in the Fama and French study where the cheaper the equity valuation the better the return.

Market Cap size was important in the Fama and French study as well (1992).   Market cap size showed a significant edge to small and micro cap equities on a monthly basis.  *Monthly returns for the smallest 10% of equities were 1.47% versus 0.89% for the largest decile.

It is our contention that there are attributes that could account for performance to equities other than social profiles and that concurrently a portfolio of socially screened equities with the highest book-to-value ratios could exceed comparative benchmarks largely due to valuation metrics and capitalization size.   In a case of pure cherry picking the monthly rate of return smallest market cap and lowest book value to market price was 1.63% versus .93% monthly for largest market cap and highest book value to market price.

I tested this theory using data supplied by the Social Investment Forum and Russell Index regarding the 10 year average rate of return for socially responsible mutual funds versus their respective benchmarks trends do emerge.

Data as of June 30, 2010

Benchmarks

  • Russell Mid Cap Value Index was the top 10 year performer +7.55%.
  • Russell Mid Cap Growth Index returned -1.99%.
  • Russell 2000 Value returned +7.48%
  • Russell 2000 Growth Index returned -.92%

Equity Large Cap performance (information provided by SIF)

  • 4 mutual funds show positive 10-year average annual rates of return:
    Calvert Social Investment Equity +0.14% (Growth)
    Neuberger Berman Socially Responsive +3.18% (Value)
    Walden Social Equity +1.46% (Value)

Parnassus Equity Income +4.65% (Value)

Equity Small Cap performance

  • 2 mutual funds from one mutual fund company showed a positive 10-year rate of return.
    Ariel Appreciation +6.16% (Value)

Ariel Fund +5.62% (Value)

Disclaimer: While the sample size of SRI fund performance is very small.  I gleaned data from only the profitable SRI funds for the last 10 years.   The SIF forum does not show fund performance information for funds that have closed, merged or liquidated.   It would be a safe presumption IMO that funds that no longer exist were weak performers since money will flock to where it’s treated best.   Plus, hedge fund performance data was not available on the SIF site.

The results do fall in line with substantial academic works (Fama and French, Lakonishok) and it is possible that SRI performance should be viewed thru the lens of Value/Growth and Market Cap size.

A logical question that must be asked upon reading this might be: “If small market cap and low valuations are the sweet spot for investing, then why are there so few funds or managers focusing on this strategy?”  Not to be obvious…………ok, well lets be obvious:  The small cap / low price to BV tends to be the focus of many private portfolio managers since our small size allows us the dexterity to invest in companies that are simply too small for billion dollar mutual funds.  Successful funds tend to outgrow the size/valuation strategy espoused by Graham as assets become larger and the investment selection becomes narrower.  But this topic should best be explored at a later date.

No holdings mentioned

Brad Pappas
President of Rocky Mountain Humane Investing
Allenspark, Colorado
303-747-0500
www.greeninvestment.com

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