VALU - Value Line: Not Yet Cheap Enough

2023-04-04 17:29:01 ET

Summary

• I think the financial results here have been quite good. Revenue is down, but gross profit is up because of heroic cost cutting efforts. The balance sheet is very strong.
• The problem is that the company was financially strong last December, just before the stock dropped 11%. Valuation matters, and it's not attractive in my view.
• In a world where you can earn 4.66% in a risk free investment, the 2% dividend yield here just doesn't "cut it" as the young people say.

Shares of Value Line, Inc. ( VALU ) have dropped about 11% against a gain of 4.5% for the S&P 500 since I suggested it would be prudent to avoid them several months ago. A wiser, more mature man than me would refrain from bragging about such a thing. Since I'm a 56-year-old with the maturity of a 9-year-old, though, you should be prepared for some bragging here. Anyway, since I’m obviously comfortable buying the stock, I thought I’d revisit this name to see if it makes sense to pick up a few shares. After all, a stock trading at $50.44 is by definition a safer investment than that same stock when it trades over $55 per share. I’ll determine whether or not it makes sense to buy back in based on the recently published financial results and the valuation.

If you read my stuff regularly you know that I care a very great deal about making your reading experience as comfortable as possible. One of the ways that I accomplish this noble task is by offering you a “thesis statement” somewhere near the beginning of each article that gives you the “gist” of my thinking. With this “thesis statement” paragraph that is hopefully both “handy” and “dandy”, you can get in, get the main points, and get out before you are exposed to too much Doyle mojo. You’re welcome. I think there’s much to like about the financial performance here. Revenue is down slightly, but gross profit is up nicely because the company did a heroic job of controlling costs. Additionally, when we compare the most recent period to the pre-pandemic era, things look even better. On top of that, the capital structure remains very strong. The problem is that financials were nearly as good when I last reviewed the investment, and the stock went on to underperform pretty dramatically. The valuation matters here, and the valuation is not compelling at the moment. This is especially so in light of the fact that the yield is about 260 basis points below the risk free rate. The dividend is growing, to be sure, but it’s not growing that rapidly. Given that I’m in the mood to preserve capital at the moment, I think it makes sense to continue to avoid this name. I’ll review again if the shares drop in price, because I think this is a wonderful investment at the right price. Thus ends my “thesis statement.” If you read on from here, that’s on you. I don’t want to read any complaints in the comments section about my terrible jokes or tendency to brag.

Financial Snapshot

I think the financial results so far this year have been relatively good. While revenue was down slightly for the first nine months of the current fiscal year compared to the same period in 2022, income from operations is actually up nicely, by 10.6%. This is because the company has done a heroic job in keeping a lid on advertising and promotion expenses, and salaries, which were down by 8.1% and 12.6% respectively. Net income is down by about 30% over the same period one year ago, but that can be attributed to last year's gain of $2.331 million on the forgiveness of the PPP loan, and on the $5.8 million drop in profits from the EAM trust.

The recent performance looks even better when we compare it to the pre-pandemic era, with revenue, income from operations, and net income up by 10.7%, 96%, and 58% respectively. Management has rewarded shareholders with a 25% uptick in dividend payments over the past four years, with 12.75% of that uptick coming in the past year.

The capital structure is very strong in my view, with cash and equity securities representing about 63% of total liabilities. The strength of the balance sheet is a rare thing these days as I think it improves the sustainability of the dividend, and de-risks the enterprise. Given that, I’d be happy to buy Value Line at the right price.

The Stock

If you’re one of my regulars, I can understand that you might be thinking "the phrase ‘at the right price’ has cost this man in the past." I admit that my fastidiousness about valuation has certainly kept me on the sidelines as stocks have run. At the same time, though, I'm of the view that it's better to miss out on some gains than lose capital. This attitude helped me avoid the 11% drop in stock price that Value Line has experienced over the past few months.

Additionally, if you read my stuff regularly, you know that I consider the "business" and the "stock" to be quite different things. Every business buys a number of inputs and turns them into a final product or service. The stock, on the other hand, is an ownership stake in the business that gets traded around in a market that aggregates the crowd's rapidly changing views about the future health of the business, future demand for investment intelligence services, future margins, and so on. The stock also moves around because it gets taken along for the ride when the crowd changes its views about "the market" in general. A reasonable sounding, if counterfactual, argument can be made to suggest that shares of Value Line would have dropped even more than they have if the S&P 500 itself wasn’t up by ~5% since. If the demand for “stocks” as an asset class hadn’t held up well, longs may have been sitting on an even bigger loss. Of course, it’s impossible to prove this point definitively, but it's worth considering. In any case, the stock is affected by a host of variables that may be only peripherally related to the health of the business, and that can be frustrating.

This stock price volatility driven by all these factors is troublesome, but it's a potential source of profit because these price movements have the potential to create a disconnect between market expectations and subsequent reality. In my experience, this is the only way to generate profits trading stocks: By determining the crowd's expectations about a given company's performance, spotting discrepancies between those assumptions and stock price, and placing a trade accordingly. I really hate to remind you of my performance here, because I’d hate to come off as a braggart, but this approach helped me avoid the 11% drop in stock price. Moving past my not so subtle brag, I've also found it's the case that investors do better/less badly when they buy shares that are relatively cheap, because cheap shares correlate with low expectations. Cheap shares are insulated from the buffeting that more expensive shares are hit by.

As my regulars know, I measure the relative cheapness of a stock in a few ways, ranging from the simple to the more complex. For example, I like to look at the ratio of price to some measure of economic value, like earnings, sales, free cash, and the like. I like to see a company trading at a discount to both the overall market, and to its own history. When I last reviewed this name, I deemed Value Line to be a bit on the expensive side when it was changing hands at a PE of 22.26, while sporting a paltry 1.85% dividend yield. Fast forward to the present and things look more expensive on a PE basis, but the dividend yield is up nicely, per the following:

Source: YCharts

Source: YCharts

Source: YCharts

Although the yield is over 266 basis points lower than the risk free rate, the company has a decent history of growing the dividend, and so the current yield may understate the income an investor can derive from the yield an investor could expect on this investment over the years.

I like the improved yield, though I’m obviously not enamoured of the higher valuation. When I find myself on the horns of a dilemma like this, I want to try to understand what the crowd is currently "assuming" about the future of a given company, and in order to do this, I rely on the work of Professor Stephen Penman and his book "Accounting for Value." In this book, Penman walks investors through how they can apply the magic of high school algebra 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 dense, 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 then infer what the market is currently "expecting" about the future.

Anyway, applying this approach to Value Line at the moment suggests the market is assuming that this company will grow profits at a rate of about 7% from here. In my view, that is a pretty optimistic forecast.

I’m of the view that in the domain of investing, everything’s relative, and we’re always hunting for the most attractive alternative. Given that these shares are still not objectively cheap, and given that it’s possible to earn 4.6% risk free at the moment, I see no value in buying this stock. I’d be happy to buy at the right price, and unfortunately the current price is not "right" in my view.

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