If you wouldn't but it today, Sell it!
Tuesday, May 6th, 2014
I’ve been so impressed with the economic news coming out over the past week or two, and yet the markets have been waiting for you to find the strong companies to put in your portfolio.
I’m still seeing some pullback in the high-fliers, but there are still some good buys to be had if an investor digs deep. Don’t be tempted by the high-fliers — most are still richly valued and priced for perfection.
I receive many requests to take a look at this company or that company, but time does not allow me to do that and still manage my clients’ $150 million portfolio. What I try to do is address a request that I think may benefit as many people as possible and that I hope everyone can take something away from.
I received an email from Kevin, saying he bought U.S. Steel three years ago and it is down 50 percent. He asks the obvious question: Should he sell or hold?
I went back to the company’s financial statements ending Dec. 31, 2010. I’m guessing Kevin probably didn’t do a lot of research before he invested in this company or, based on what I see, I don’t think he would have bought it — or at least I wouldn’t have.
What I found was a company that had $1.2 billion in cash and short-term investments, a debt of $3.7 billion and equity of $3.9 billion. However, $2 billion of that equity came from goodwill and intangible assets. Remember this as we go forward.
I also looked at the income statement from 2010 and saw sales of $17.3 billion and operating expenses of $17.5 billion, which means there was an operating loss of about $200 million.
Traveling all the way down to the net profit margin, an investor would realize the company lost $482 million, or $3.36 per diluted share — not a winning combination. In my opinion, this stock should have not been bought at $52 a share or any price at that time.
Now that U.S. Steel trades about $26 share and some things have changed, the question is: Has it changed enough to warrant holding onto in hopes that the stock price will increase?
Today, the company now has half the cash, or $604 million, and the debt has increased to $3.9 billion. The big change is that goodwill and intangible assets are now $200 million. You may — or should — ask where the other $1.8 billion went. It was written down and it is a hit against earnings.
Now, while management or others will say, “Don’t worry about it. There was no cash going out the door,” it is a hit on the equity and that’s why, one year later, there is $500 million less equity.
Think of it this way: How did you feel back in 2009 when the value of your house went down? Probably not very good. Your net worth went down and even though no cash went out the door, you were worth less. The same holds true for company write-downs.
With the decrease in equity and increase in debt, the debt to equity is now 118 percent, compared with the industry at 60 percent. That is like owing $118,000 on a $100,000 home — it’s just not good.
There are a couple of positives that I see from the company, such as positive cash flow of $400 million. I also noticed that the earnings per share turn positive and the mean estimate is $1.50 for the year ending December 2014, and then jumps to $2.32 for the year ending December 2015.
With the current stock price about $26, that would yield a reasonable forward PE of 11.2, or a target sell price of $38 per share. Still not back to the $52 per share or so, but a 46 percent gain from current levels.
If management were to use some of that cash flow to pay down some debt and the equity were to climb because of good earnings and good management, it may make sense to hold this company.
But that’s a lot of ifs and I always say, “If you wouldn’t buy it today, then sell it.” That doesn’t mean the stock won’t go up, but an investor has to make smart decisions and realize that you won’t be right all the time, even though you did the right thing.
Wilsey is president of Wilsey Asset Management and can be heard at 8 a.m. every Saturday on KFMB AM760. Information is provided by Reuters.
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