AMOT - Allied Motion Is Still Too Expensive

Summary

• The company has reported earnings since I last reviewed the name. Although sales growth is impressive, earnings have actually fallen. Additionally, debt has exploded higher.
• In spite of this, the shares remain either "expensive" or "not cheap", depending upon how you measure it.
• I wrote puts that have just expired worthless. These have offered a superior risk adjusted return in my view, offering yet more evidence of the power of these instruments.

It’s been just under three months since I recommended people continue to avoid Allied Motion Technologies Inc. ( AMOT ), and in that time the shares have returned a positive 9.12% return against a loss of 7% for the S&P 500. On the eve of their upcoming earnings announcement, I thought I’d check back in on the stock to see if it makes sense to buy or not. Since the company has released financials since I last reviewed the name, I’ll have a look at those, and I’ll check out the stock as a thing distinct from the underlying business. After all, earnings may be up even further than the stock, so what was “too expensive” at $28 may be a bargain at $30. Finally, the puts I wrote against this stock expired last Friday, and I’m absolutely champing at the bit to write about those.

Welcome to the “thesis statement” paragraph. I insert this paragraph near the beginning of each of my articles for the benefit of those who want a bit more than the title and bullet points , but can’t stomach the thought of a full serving of Doyle mojo. You’re welcome. Anyway, I think it would be wise to continue to avoid this stock until it drops to match value. Although sales growth has been impressive, net income has fallen, and owner shareholders are compensated by growth in earnings. At the same time, the capital structure has deteriorated significantly, which has amplified the level of risk present in my view. Speaking of risk, the puts I wrote earlier have just expired. The $1.25 I earned on these deep out of the money puts is, in my view, a superior return to those generated by shareholders. I exposed myself to much less risk to achieve a superior return. This is evidenced by the fact that the shares are worth about $1 less today than they were when I wrote my puts. I don’t mention this only to brag, though that’s a very pleasant side effect. I mention this to point out, yet again, that short puts are a great way to generate decent returns at much lower risk.

Financial Snapshot of Allied Motion

I don’t disagree that this company has the capacity to grow. After all, revenue is just under 17% higher than it was this time last year, and over 27% higher than it was before the world went into lockdown. This is, in some sense, a “growth” company. That’s not unexpected in my view, given that they operate in some high growth sectors. For instance, they facilitate factory automation, surgical robotics, and offer crucial components in unmanned vehicles for the aerospace and defense industries. Feel free to read more about the growth story here by checking out the company’s latest investor presentation. In my view, sales growth is great when it leads to growth in profits. This is the whole point from an investor’s point of view in my opinion, because investors are owners, and owners only get paid after employees, landlords, and suppliers. Additionally, every government needs to wet their beak. I mean, they need a taste. Thus, I care about growth in sales when it impacts growth in profits. Unfortunately, it’s not doing so in this case, because costs are rising at a faster rate than sales. Although sales during the first six months of this year were 17% higher than they were in 2021, net income was down by 57%. Net income for the first six months of 2022 was also about 20.5% lower than it was in 2019. This does away with the idea that 2021 was a particularly challenging comparison year.

Put another way, what’s the point of growing sales 17% when the company grows selling expenses, engineering, and business development by 25.8%, 35%, and 1200% respectively?

If you thought I was going to moan only about the income statement and move on, prepare to have your expectations subverted. The capital structure has deteriorated fairly substantially over the past year. Long term debt is higher by 103% now, and the company’s increased its revolving credit facility to $280 million from $225 million. This is convenient because long term debt is now just under $229 million. Although the cost of this debt is now slightly lower, based on SOFR, interest expenses are about 54% greater now than they were in 2021. In my view, the added debt adds to the level of risk present. I’m not sure how aware you are, but interest rates have been on the rise of late. Such a circumstance is awkward for a company that has increased debt to this degree. In fairness, though, the company has just under $29 million in cash, so the capital structure isn’t the worst I’ve seen. That said, if I were a shareholder I’d like to see debt much lower.

All that written, I’d be happy to buy the stock at the right price.

The Stock

My regular readers know that I consider the company and the stock to be very different things. If you’re new here, it’s time to let you in on this idea, too. I consider the stock and the company to be very different things. The company takes a number of inputs, adds value to them, and sells the results to someone else for a profit. The stock, on the other hand, is a traded instrument that reflects the crowd’s long term views about the strength of the business. Additionally, the stock is affected by a number of variables that have little to do with the business, including changing interest rates, the crowd’s desire to own “stocks” as an asset class etc. In my experience, the only way to profit trading stocks is to spot discrepancies about the crowd’s views and subsequent reality. If the crowd is too pessimistic, for instance, it makes sense to buy and then ride the price higher as new information is eventually digested.

I measure the cheapness (or not) of a stock in a few ways, ranging from the simple to the more complex. On the simple side, I look at the ratio of market price to some measure of economic value, like earnings, sales, and the like. I want to see the shares trading at a discount to both the overall market, and to their own history. On that basis, things are even less compelling now. When I recommended avoiding the shares previously, the PE ratio was about 28.05. It’s now about 13% more expensive per the following:

At the same time, the market seems to be paying in the mid-range for $1 of sales from the company, per the following:

None of this suggests to me that the shares are currently a “screaming buy.” Ratios of this sort are relatively unsophisticated, though. In addition to looking at ratios, I want to try to work out what the market is "thinking" about a given investment. If you read my stuff regularly, you know that the way I do this is by turning to the work of Professor Stephen Penman and his book "Accounting for Value" for this. In this book, Penman walks investors through how they can apply some pretty basic math to a standard finance formula in order to work out what the market is "thinking" about a given company's future growth. This involves isolating the "g" (growth) variable in this formula. In case you find Penman's writing a bit opaque, you might want to try "Expectations Investing" by Mauboussin and Rappaport. These two have also introduced the idea of using the stock price itself as a source of information, and we can infer what the market is currently "expecting" about the future.

Applying this approach to Allied Motion at the moment suggests the market is assuming that this company will grow earnings at a rate of ~8% in perpetuity. I consider that to be a fairly optimistic forecast. Given the above, I can’t recommend buying at current levels. The company is growing sales, but not income. Net income is the most relevant variable for owners of any business. The stock is either “neither cheap nor expensive” or “expensive”, depending upon how you measure it. I think there are greener pastures elsewhere, and for that reason I recommend continuing to avoid this name until the price comes down to match value.

Options Update

Although I don’t see value at the current price, I think at the right price, this could be an excellent investment. For that reason, I wrote 10 October Allied Motion puts with a strike of $25 for $1.25 each. These expired worthless this past Friday. Although they spiked in price up to $3.20, I’m of the view that they offered me a superior risk adjusted return when compared to the stock. I was either going to earn $1.25 in premia, or I was going to be “forced” to buy this stock at a net price of $23.75. Thus, I think this $1.25 is in some very real sense a superior return to those achieved by stockholders. I’d remind investors that the shares are about $1 lower than they were on the day I wrote these puts which were, at the time, deep out of the money.

While I like to try to repeat success when I can, I think the market remains excessively optimistic about this stock at this time, and therefore the premia for stock insurance is too thin. Given that, I’d avoid short puts until the shares inevitably fall in price.

For further details see: