Why You Should Buy Businesses, Not Forecasts

As the New Year gets under way there has been lots of predictions, discussion, ruminations and outright guesses about what will happen in the stock market over the next 12 months.

The truth is that this is unknowable in advance. There is a lot that can go right, as many global economies are showing signs of improvement, but there is also a lot that can wrong in 2014. To make, or even worse - trade, on predictions about what might happen is usually a recipe for disaster in the stock market. Investors would be better served by concentrating on what stocks are cheap and have substantial recovery or asset conversion potential in the next few years.

Ignoring the market and focusing on investing in companies at very cheap prices compared to the value of the firm itself makes mores sense for most investors.

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Richardson Electronics (RELL) is an example of a company where investors can make an intelligent, business-like investment decision and own a solid company at a discount to its asset value. The company is a global provider of engineered solutions and a leading distributor of electronic components to the electron device marketplace. They do business in 43 companies around the world and serve a diverse range of industries including alternative energy, broadcast communications, industrial equipment, marine avionics, medical and healthcare, and semiconductor.

Although the recently reported results were a little weak, they did surpass Wall Street's always highly accurate expectations. CEO Edward Richardson also pointed out on the follow-up conference call that sales results at the end of the year were strong. November ranked as the highest sales month of the year and he was confident that momentum would carry into 2014.

He also told investors that they were looking to expand in the medical markets, saying on the call “During the quarter we continued to evaluate potential acquisitions in the diagnostic imaging replacement parts market. We remain convinced that the demand for high quality replacement parts will increase as healthcare reform makes it more critical than ever for hospitals to focus on reducing costs in the face of declining diagnostic reimbursements. We firmly believe we can play a significant role as an independent parts supplier in the healthcare market in the future.”

The stock is very cheap at the current price. The shares trade at 90 percent of tangible book value and just 120 percent of net current assets. The company pays a dividend and the shares currently yield 2 percent. In addition to the dividend, management has been spending some of its cash to buy back stock. Since 2011, the company has spent $56 million to repurchase stock at very favorable levels. It is a good business at a great price and owning the shares makes good business sense at this price.

Hopfed Bancorp (HFBC) is another investment that makes good business sense. Hopfed is the holding company for Heritage Bank, which operates in Kentucky and Tennessee. The bank has a solid balance sheet with an equity to assets ratio of 10.9 and non-performing assets that are just 1.46 percent of the banks total assets.

The bank has 18 branches with about $928 million in assets. The shares are cheap at a little less than 90 percent of tangible book value.

The bank has underperformed for some time with a return on assets and return on equity that was well below its peers. This has attracted the attention of several activist investors, including PL Capital and Joseph Stilwell. Mr. Stilwell has been particularly aggressive in dealing with the bank and in his most recent 13D filing remarked that “Our purpose in acquiring shares of Common Stock of the Company is to profit from the appreciation in the market price of the shares of Common Stock through asserting shareholder rights. We do not believe the value of the Company's assets is adequately reflected in the current market price of the Company's Common Stock. “

Resolutions For The New Year & Beyond

He engaged the bank in a proxy fight and has forced them to cancel a poor acquisition, double the dividend and initiate a stock buyback of 500,000 shares. He has also placed a representative on the board and is urging the bank to increase shareholder returns or sell the bank in the near future.

An investment in the bank at this level makes good business sense. The stock is cheap and the balance sheet provides a margin of safety. There are large shareholders pushing for increased shareholder values and there is broad recovery in the baking industry that can provide additional tail winds.

Speculating and predicting the eventual direction of the stock market can make for interesting discussions, but carry the potential for disastrous results when the inevitable black (or white) swan turns up to spoil your expectations. It is far more profitable to take a business-like approach to investing in the stocks and use common sense and valuation to guide your investment decisions.