Stock Idea Updates

Emergent Group (LZR)

Emergent Group, one of my favorite stocks, was recently bought out for a decent, but not outstanding premium. When I wrote about it almost a year ago, it had a market cap of around $50 million. Since then, the stock fell significantly to around $35 million, at which point I bought a little more. They also paid their usual dividend of a little under $3 million, plus a special dividend of about $3.5 million. In the end, they sold out for about $58 million to Universal Hospital Services, which I personally believe was a bit on the low side.

Defense Industries International (DFNS)

This little net-net attempt hasn't done much. The only significant news to report was that the chairman, who owned (through inheritance) about 69% of the stock, sold her stake to a private investment group for about $0.11 per share, which is a few cents lower than when I mentioned it (read: bought it for myself). The good news is that they recently had a profitable quarter, and their net asset value is still intact.

When to Sell

When you buy a stock, the ultimate goal is to realize a profit by eventually selling it. While there is a plethora of information on selecting the right stock and determining when to buy it, the subject of selling remains somewhat ignored. Prudent selling, like buying, is an art that requires a strong stomach, thorough analysis, and faith in your decision. Waiting too long to sell a stock and seeing the price drop or dumping too soon and seeing the price rise is just as painful as making a buying mistake. With that said, here are some good (and not so good) reasons to sell:

Good Reasons To Sell

You have achieved your goal

Oftentimes when buying in a stock, you determine an exit point. This may occur if you invest in a company that is trading at a significant discount to its net asset value, or some other “cigar butt” situation. In any case, if the stock price has hit your target, then you should take your profits and sell.

You realize you made an error in your analysis

Before investing in a stock, you have hopefully carefully scrutinized the company’s financial statements. You have looked to make sure it has a healthy balance sheet, it is consistently profitable, it has growth potential, and it is an overall quality business. However, you may realize after you have purchased the stock that you have made a mistake somewhere. You may have overestimated future growth or profit margins, and it may or may not have already affected the stock price. Nonetheless, it is best to get out in this case.

High valuation

You may be invested in a truly superb business that has performed well in the past and is poised to do well in the future. However, if everybody else is similarly optimistic or even euphoric about the prospects of the company, then there is a good chance that it is highly overvalued. If you have done a valuation yourself and the current market price is significantly higher than the fair value that you’ve determined, then it might be time to trim your position or even sell the whole thing and wait for a more appropriate entry point.

The company is losing its long term luster

The best companies to own are those with strong competitive advantages in industries that are projected to grow well into the future. These advantages don’t hold forever though. If they did, then Sears and General Motors would still be thriving components of the Dow. If you can see that the company’s economic moat is deteriorating due to higher competition or some new technology that is threatening its livelihood, then you should consider selling the stock.

You found a better opportunity

This is my favorite reason to sell a stock. If you’ve found some other stock that you believe has fantastic potential but you don’t have enough cash to buy it, then you should sell your stock with the least promise to fund the purchase. You may only need to sell a portion of your holding, but you can rest assured that your overall return will be greater as a result if your analysis is correct.

Bad Reasons To Sell

The stock price is volatile

If you have done your analysis and are confident in the price at which you bought the stock, then you should do your best to ignore short term volatility. If the market overreacts to quarterly earnings or if the price unexpectedly drops five percent, you should not be deterred as long as your original convictions about the stock still hold.

The stock price is stagnant

For me, impatience is a greater sin than skittishness. If you’re concerned that the price “hasn’t moved” in a while and you’re not getting immediate results after buying the stock, you need to reconsider why you invested in the first place. If you invested at the right price with the intention of being a long term holder, then you may have to endure a couple of years of stagnation. You will be rewarded in due time, but getting bored and selling the stock is no way to profit for the long haul.

Net-Net Idea: Defense Industries International (DFNS)

I wrote earlier about the pitfalls and potential opportunities of net-net stocks. Well, I've come across what I think could be a winner. The name is Defense Industries International, and it's a tiny (and I mean tiny) Israeli manufacturer of civilian and military personal protective equipment. This is mostly body armor, but they also sell things like shields, tents, ballistic wall covers, and collapsible liquid containers. Its largest customer is the Israeli military, but it also has a diverse client base across North America, Europe, Africa, and Israel in both the civilian and military markets.

Test #1: Does It Make Money?

Like I said before, this is a small company, but a profitable one nonetheless. Over the past five years, it's averaged only about $15 million in revenue and a couple million in net profits and free cash flow. The growth isn't really anything to write home about either. Over those five years, revenues have grown by a total of about 55%, but the last year has shown a slowdown, naturally due to the poor condition of the worldwide economy. Also, it doesn't seem like a lot of these revenues are recurring, and the company is fairly dependent on business from the Israeli military.

Test #2: Are The Assets Valuable?

In a word, yes. Defense Industries has about $14 million in current assets, half of which are cash or short term investments. It only has $4 million in inventory, which I highly doubt will become obsolete anytime soon. As far as liabilities, the company has about $5 million in total liabilities on its books, almost none of which is long term debt. In net-net terms, this leaves a net current asset value of anywhere between $6 million and $8 million, depending on how conservatively you want to value the assets.

Test #3: Is It On Sale?

As of recently, Defense Industries International has a market cap of under $3.4 million ($0.12 share price). With about $7 million in net current assets, a million in earnings, and some extra PP&E that wasn't included in the net asset calculation, it looks like this could be a steal.

Conclusion

Of course, rarely is a net-net a complete slam dunk. There are clearly huge risks with a stock like Defense Industries, even if it does look like a bargain from the financial statements. First and foremost, it is a miniscule company that is up against much larger competitors that sell the same if not superior quality products. Its revenue base is diverse, but that does not mean it is particularly strong. This could mean that the slim profits could quickly turn to losses, eroding those valuable cash reserves. Furthermore, the stock trades very thinly and has lately been in a very tight range. Shares might only change hands once or twice every other day. Additionally (and probably most troubling to outside investors), the chairman owns about 70% of the stock, so the company is essentially at her mercy.

However, I think that the company does have a potential catalyst. I believe that the fact that it is in Israel and sells to the military there offers some upside potential considering the country is seemingly in a perpetual state of war. This might not mean much, but I certainly believe this fact coupled with the enticing valuation warrants some additional research on Defense Industries International.