VALU - Value Line: More Risk Less Return Than A Government Bond

2023-09-14 08:03:05 ET

Summary

• Value Line, Inc. has reported quarterly earnings, with shares underperforming the S&P 500.
• The company's financial performance has been very good, with an increase in operating profit and net income in spite of a slowdown in revenue.
• The problem is the valuation. The large negative risk premium is concerning, so I recommend holding off until prices drop to the low $40s.

It's been a little over 5 months since I last reviewed Value Line, Inc. (VALU), and, in case you forgot, in that article I suggested that the shares were not cheap enough to invest. Casual readers may have gotten a sense of that thesis from the dynamically titled article: "Value Line: Not Yet Cheap Enough." The company has just reported quarterly earnings again, so I thought I'd review the name once more. Since I published the above article, the shares have returned about 4.8% against a gain of about 9% for the S&P 500. This underperformance has me intrigued. Additionally, I've done well with this stock , so I'm obviously comfortable buying it at the right price. Today I want to work out whether or not it's trading near a reasonable price, and if it is, I'll take a small position.

I'll make that determination by looking at the latest financial results, and the valuation.

Welcome to the "thesis statement" portion of the article. It's here where I give my readers a bit more than what they get from the title and bullet points, but much less than they would get if they read the whole piece. I do this because I'm powerfully driven to make your reading experience as pleasant as possible, and saving you time with a thesis statement is one of the ways that might happen. You're welcome. I really like this business in many ways, and I think the most recent financial performance has been excellent. In spite of a slowdown in revenue and an uptick in taxes, the company managed to increase operating profit and net income. Additionally, book value is moving in the right direction here. My problem, as usual, is the price paid for this great performance. It (still) doesn't make sense to me that investors are taking on more risk, relative to a government bond, and receiving less than half of the income stream they'd get on a risk free investment. I think there's a strong negative relationship between price paid and subsequent returns, and I think that relationship will eventually become apparent in this case. When that happens, if the shares drop precipitously in price, I'll likely buy back in. For now, though, I must remain on the sidelines.

Financial Snapshot

I think the financial performance has been rather good, actually. In spite of a 2% decline in revenue from last Q1 to this, income from operations and net income are up by 7.5%, and 9% respectively. The quarter wasn't a disaster because of the company's successful cost-cutting efforts. So, advertising expenses declined by about 6%, salaries were down 7.6%, and "office & administration" was down 16.6% from last year. These efforts resulted in an uptick of only $4 million in operating costs from the year ago period. Additionally, revenue and profits from EAM Trust and investment gains added another $303 thousand to the bottom line, which more than made up for a $93 thousand uptick in income tax expenses for the quarter.

Additionally, I continue to be impressed by the balance sheet here. Shareholders' equity is up another 2.2% from the same period a year ago, and is up fully 74% from the pre-pandemic era. That, the latest financial performance, and the fact that the dividend remains very well covered in my estimation, is enough to make me strongly consider buying back into this business if the price is right.

The Stock

My regulars know what time it is. They know that I'm about to blather on about the fact that I consider the business and the stock that supposedly represents the business to be two very different things. The business makes money by selling investment periodicals. The stock, on the other hand, is a piece of virtual paper that gets traded around in a public marketplace, and represents a claim on the future cash flows of the business. The stock moves up and down in price because the consensus on future cash flows changes rapidly. In addition, the stock is buffeted by forces that have little to do with the business such as a speech by a central banker. In case you're still of the view that "we don't buy stocks, we buy businesses", please consider the following thought experiment involving two hypothetical investors with the mind-numbingly original names: Investor A and Investor B. Investor "A" bought this stock on August 21st, and Investor "B" bought the stock the next day. As of this morning, investor A is up about 1.7%, while investor B is down about 12.5%. For those keeping track at home, that represents a discrepancy of 14.2% in one day. The difference between this being a "moderately good" or "disastrous" investment came down to price paid. Since investor "A" bought the shares at a lower price, they did better.

I like lower priced stocks because they offer the greatest combination of higher returns at lower risk. They represent the potential for higher returns because any bit of good news may very well send shares higher when only bad news has been "priced in." They represent lower risk because at some point, the market just expects terrible results, so the stock doesn't have much farther to fall. This tendency on my part to buy when the crowd is most pessimistic is a way of playing against crowd expectations.

As my regular readers know, I measure "cheap" or "low expectations" in a few ways, ranging from the simple to the more complex. On the simple side, I like to look at the ratio of price to some measure of economic value, like sales, book value, and the like. I want to see a company trading at a discount to both its own history and the overall market. In case you don't have your latest copy of "Doyle's Almanac of Trades" in front of you, I'll remind you that I continued to eschew Value Line when it was trading at a PE of about 26 times, a price to sales ratio of 11.6 times, and sported a dividend yield of about 2%.

Fast forward to the present, and not much has changed. The improved business is reflected in the higher stock price, so valuations are virtually identical. I remain disturbed by the fact that the dividend yield remains about 212 basis points below the risk-free rate . While there's room for growth in the dividend, I don't know if the potential is great enough to account for this wide a spread.

I really like this business for so many reasons. The dividend is well covered, management seems to be very shareholder friendly, and book value keeps growing nicely. The problem is that the shares are not sufficiently cheap. This is troublesome in my view, because I'm of the view that there's a strong negative relationship between the price paid for an investment and the future returns on that investment. Additionally, the company sports a pretty hefty negative risk premium. So, investors are taking on relatively more risk and receiving relatively less reward. This makes zero sense in my estimation, and for that reason, I'm going to recommend continuing to eschew the shares.

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