Value In Action: Nu Horizons

Six months ago, we discussed Nu Horizons (NUHC) as a potential value investment. Yesterday, it rose 102% after receiving a buyout offer with a hefty premium. Therefore, today the stock moves off of the Stock Ideas page and onto the Value In Action page. Here are four lessons one can take from this type of investment that reinforce "value investing" principles.

1) Basing a company's value on its current earnings is a poor idea

Current earnings fluctuate. Particularly during a recession, current earnings are not a good gauge of what a company can earn, or what a company is worth. Instead, investors should look at normalized earnings as well as assets (particularly liquid ones) in forming a valuation opinion.

2) Identifiable catalysts are not necessary

There was no reason to believe that Nu Horizons would be bought out. If there were, the stock probably would not have traded at such a large discount to its assets. When investors buy businesses for much less than what they are worth, the odds are very much on their side when it comes to receiving a favourable return. Subjectively applying catalyst values could result in missed opportunities.

3) Book value matters

Many investors believe book values to be completely irrelevant. Value investors know that just isn't correct. In buyout cases such as this one, where return on capital has been around or below the cost of capital, the transaction price is often quite close to book value. This is because it would take the acquirer around that much money to build up the assets that they seek internally. But they do save time by making an acquisition, and they do acquire intangibles such as customer/supplier relationships and know-how, which is why this type of acquisition often takes place at a premium to book value.

4) A variable cost structure helps

The recession and the ensuing loss of a supplier took a bite out of Nu Horizons' revenues. But because the company is not burdened with a high percentage of fixed costs, the company was able to adjust and return to profitability relatively quickly. Undoubtedly, this helped it secure an asking price that was above, rather than below, book value.

Disclosure: None