I like Dan Ferris. I’m sure I disagree with him on a lot of things, I don’t know him personally, and I don’t know what his overall long term track record is at Extreme Value (the stocks we’ve covered have included both hits and misses, with more of his best returns that we’ve looked at coming from buying “world dominators” during market declines, like 2009-2011, than from his smaller and more obscure value-oriented picks), but he’s got an interesting and charmingly stubborn focus on value investing, I’ve found some of his recommendations compelling over the years, and he usually does a good job with his Stansberry podcast… and that makes him a fun counterpoint to a lot of the silliness in the investing world these days. We at least know he’s not going to get all hot and bothered about the latest hot NFT, or some sexy growth stock that’s spending $10 to make a dollar in sales and defying all logic.
And he’s been running a big promo campaign for Extreme Value subscribers lately, a group that I think he said now numbers 40,000 (which would be very good for a high-priced letter — $1,500 for two years, no refunds, in this particular deal — so maybe that’s an overstatement or I misheard, that would mean Ferris’s newsletter, by itself, is generating something like 10% of the revenue of now-public Stansberry/Palm Beach/Investorplace/Empire/Brownstone/Casey parent MarketWise (MKTW), which is very unlikely). This is the first big push for Ferris that wasn’t built around his tease of Sprott that I can remember in recent years (that’s what he called “the hands down, #1 pick of my career” for about three years, I saw the ads from early 2018 through the beginning of this year), so who knows, maybe this one will stick around for a while, too. (That Sprott pick, by the way, has had its ups and downs but is currently doing a little better than other gold names, on average).
But anyway, the tease is not necessarily about his current recommendation, but for a “special report” on what he says is his “Smallest Extreme Value Stock in 7 Years” — a company with a market cap below $300 million. Here’s how they introduce the spiel…
“This is the smallest company I’ve recommended in Extreme Value in seven years. Its market cap is currently less than $300 million. But it won’t stay that way for long…
“This company checks all the boxes that Mike and I look for in a great business. And our research has led us to believe that this stock could triple (or more) over the next two years.”
What are those “checkboxes” that Ferris uses? Here are my notes of the part where he goes over his “five criteria” —
Five criteria for finding a good value investment
1. Tons of cash generation. Good free cash flow, which is the excess profit left over after paying expenses and reinvesting enough to maintain and grow the business. Equity holders get paid last, so you need to make the company generates a lot of money to reward them.
2. Consistent margins. Need to control your costs and know what you’ll pay — it’s normal for margins to erode with competition, so a consistent profit margin (he mostly refers to operating margins) is an economic anomaly that tends to favor investors.
3. Iron clad balance sheet. You want a company that’s never worried about going bankrupt, and has a lot more cash than debt, or at least earns enough money to easily cover their debt payments.
4. Shareholder rewards. “What’s in it for me?” Do they pay cash dividends or repurchase shares?
5. Return on Equity. Return is the earnings of the business, the net income… “equity” is “net worth” (assets minus liabilities). Consistent ROE of 20% or higher is pretty fantastic.
So that’s the general backdrop, nothing surprising or stupid there, of course, the rub is that you have to find these companies and buy them at sensible prices… and understand them well enough to know when or if the company changes for the worse.
So what clues do we get about this particular pick from Extreme Value, the idea that he’s pitching as his “My No. 1 value play today could TRIPLE your money in under a year… but you need to take action NOW” stock?
“… for the 40 years they’ve been in business they’ve done TWO very important things.
#1. They design and sell thermal equipment used for manufacturing activities, like forming metals with precise heating and/or managing extreme temperatures. And…
#2. They design and sell products used primarily by semiconductor companies to automatically test the chips they manufacture for defects.”
So that semiconductor bit is where the urgency comes in, I guess — he says “you’re getting a little-known, small-cap stock, just as the next big upturn in the semiconductor industry is beginning.”
Other clues? He refers to it as a “$14 stock”, and he goes through the five criteria I noted above — the company has had excellent and pretty consistent free cash flow every year, except for 2019, and his note about that counts as another clue:
“I understand there was a dip in 2019, but after I dug into the company, I learned it was an “earnout” payment related to an acquisition they made in 2017.”
What else? He also talks about “consistent margins” with this one, but switches over to gross margins when he highlights that consistency (perhaps because their operating margins and net margins have not been as consistent), and to highlight that he shares a chart of their margins from 2011-2020, so we get a few more clues to feed to the Thinkolator — including that hte gross margins for the last five full years were 44.8, 48.2, 50.2, 51.9 and 50.7. And that their worst year was 35, back in 2012, the only one that didn’t really stay in that same range.
And we’re told that they have a “pristine, debt-free balance sheet,” with “$10.2 million in the bank.”
And that they do not pay a dividend, but do share repurchases most years.
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One final clue? That key metric Ferris cites, return on equity (ROE), was negative last year, with the downturn in the semiconductor market while supply chains went kablooey (my words, not Ferris’), but we also get a chart that indicaates it has mostly been between 5-10%, and pretty consistent, with 2017 the only other “below 5%” year since 2011. From the ad:
“With the VERY low supply of semiconductors out there right now and the demand skyrocketing, I expec