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By Maj Soueidan, Co-founder GeoInvesting
I hope all of you enjoyed your transition into the New Year. Like I do at the beginning of each new year, I’ll be pondering a few investing resolutions. The 2022 reset probably forced many of you to ask yourselves,
“What could I have done better to adjust to changes in the investing environment – decisions regarding sell discipline all the way to what type of stocks to hold and new ones to buy?”
While in that same frame of mind, when I reflect on the impact the great recession of 2008 had on the way I had been accustomed to investing, three things stand out.
First, holding a diversified portfolio of microcap value-themed stocks became challenging.
For many years, post 2008, there was not a broad investor appetite for these types of stocks. It forced me to become more of a concentrated investor and sometimes choose stocks that were more in-line with what the market environment dictated.
Second, the valuation multiples for these types of stocks were not reaching the levels attained in prior bull markets. This reality was the hardest pill to swallow, since buying stocks ahead of a valuation multiple expansion period, due to a new growth phase being reached, has always been a big part of my strategy. A double stroke of fortunate circumstances – increasing earnings per share growth coupled with an expansion in price to earnings multiples – can result in a powerful multibagger scenario.
Third, it was unclear if super cheap stocks of solid companies that were not growing would stay unreasonably cheap or if they would even experience valuation multiple contraction.
15 years of this broken record is tough to take as it becomes habit forming. You begin to think that microcap value will permanently trade at depressed valuation multiples.
However, as I have been obsessively writing about, the outlook for microcap value is improving.
An example of a stock that I bailed on because of the “bad habits” I had formed that turned out to increase 195.57% is Virco Manufacturing Corporation (NASDAQ:VIRC). I kind of want to forget, but I have to remember to vie for a best attempt at preventing history from repeating itself.
Incorporated in 1950, Virco designs, produces, and distributes furniture in the United States, with a special emphasis on seating and workstation solutions for schools and other large-footprint operators like convention centers, places of worship, government facilities, and arenas, among others. Annual revenues are running at about $270 million.
On September 2, 2022, we published the reasons why we were bullish on VIRC and included it in our Model Portfolio at $4.19. The stock was trading at a P/E of around 10x on forward annual EPS estimates.
The stock closed out 2023 at $12.03, off its 52-week high of $12.65.
A few things had initially attracted us to the stock, including a “lights out” quarter the company had just reported, a large backlog, a return to profitability after 3 years of losses and increased latitude in passing price increases to its customers for the first time in years.
I then had a decent interview with management. With a 50% market share position, I learned that VIRC was the leader in its industry, and was going to benefit from reduced competition as a result of China exiting the industry in the U.S. Therefore, I figured that the company was about to embark on a new period of revenue growth, accompanied by strong earnings per share growth.
The company also issued a presentation in June for the first time in years, laying out all of the new bullish currents happening at once.
However, VIRC’s business is very seasonal, with the first and fourth quarters posting historical losses and the remaining quarters usually posting strong but volatile profitability.
In the end, despite the low valuation, we just couldn’t get over some of the potential unpredictability to growth. We were also not sure if valuation multiples would expand. In fact, the P/E contracted for a bit.
Then, the company reported lousy Q4 2023 results, (quarter ended on January 31, 2023), missing expectations by a huge margin on all fronts. This, coupled with verbiage in the 10K filed with the SEC prompted us to remove the stock from our Model Portfolio at $3.88.
The filing contained some cautionary commentary about order uncertainty due to economic conditions.
Well, it turns out that the weak financial outing was just a bump in the road. Growth has been strong for 3 consecutive quarters, leading management to reinstate its dividend and the board to approve a $5 million share repurchase program.
Today, at $12.03, the stock is trading at the price to earnings multiple 7x on this year’s earnings per share expectations, less than what it was when we first wrote about it, yet the price is nearly 200% higher!
To be perfectly honest, given the state of the markets at that time, if I had a chance to go back and reassess the situation, I don’t know if we would’ve done anything differently. Instead of crying over spilled milk, I am looking at this with a sense of optimism, glad that common sense investing seems to be working again. There was a time that VIRC would have not risen in reaction to the company’s progress.
When looking at stocks with insanely low valuation multiples, it doesn’t take much for them to move because a lot of “value trap” risk is priced into the stock.
Luckily, there are still plenty of stocks trading at absurdly low valuations that could see huge re-rates in valuation multiples if they can show the slightest bit of evidence that the circumstances negatively influencing their valuations are improving.
With annual revenue tracking about $240 million, Paul Mueller Company (OOTC:MUEL), trading at $58.00, is an interesting low valuation example that carries a considerable amount of perceived value trap risk.
We most recently began coverage of the company at the end of last July when the stock was trading at $46.00, alongside one of our GeoInvesting contributors, Tim Heitman (here, at the end of August). MUEL is a 83-yr old company that builds processing equipment worldwide for dairy farms, food and beverage, pharmaceutical, and chemical facilities.
In mid-November, I posed a question on Twitter (X) that I hoped would open a small discussion on whether the market was missing something or if the stock was a value trap, due to the company’s terrible history of being able to grow the business, confusing FIFO/LIFO accounting and a large underfunded pension liability putting demands on cash.
These reasons are why, despite the company reporting incredibly strong earnings for the last four quarters and having a cash balance per share of $38.00, shares are trading at a meager P/E of 3.5x, even after increasing 26% since we wrote about it!
But, as we have mentioned in our ongoing coverage, some things have happened that may indicate management is addressing ways to enhance shareholder value. They include:
- Settling and eliminating the large pension liability from the balance sheet.
- Focusing on higher margin markets.
- Shutting down unprofitable divisions.
- Expansion of manufacturing capacity.
- Management narrative getting more friendly and transparent.
We have yet to interview management and there are clearly some unknowns to MUEL’s growth outlook. However, MUEL is an interesting set-up, where a P/E of 10x or 15x might not be out of the question if the past is well, in the past. What if the Board approves a share repurchase program?
This brings me full circle to one of my New Year’s resolutions: To not avoid all value traps, but embracing some by holding tiny positions in a diversified set of super cheap value trap stocks and not panic selling, where management is showing some signs of progress of de-risking the business. These transitions can take time.
The nice thing about tiny positions in super low valued stocks is that the large multibagger upside can offset the losses of the bets that do not work out.
Have a great investing week. And more importantly, an awesome 2024.