Red Flag #1: Missed Earnings Expectations
Earnings are one of the most important "tells" when analyzing a company's future prospects. Earnings are the pre-eminent indicator of how well the company is progressing toward its goals, and also how well it is managing its bottom line along the way.
When earnings season comes around, investors stay glued to their TVs or the Internet to see how their companies fared for the quarter. And more often than not, if actual and estimated earnings differ by even a penny, the stock gets killed!
That's why most companies like to keep an open line of communication to the analysts who follow them. That way, Wall Street's earnings projections closely mimic the company's, and they are not caught out-of-sync.
But sometimes stuff happens, and every company can have a bad quarter. The past year and a half has definitely shown us that, hasn't it? In fact, most companies–until this most recent quarter–have posted some pretty lousy results, many missing their estimates by a mile.
I've found that you can count on this: If you are in the market for any length of time, some of your holdings will undoubtedly suffer similar fates. But since I tend to take a long-term view of the market, I don't sweat one missed estimate–as long as I can determine that the company is on the mend and no serious fundamental concerns have come to light.
However, my alert button really turns red when a company keeps missing estimates. When that happens, it tells me that the business has some underlying problems. Maybe it's in an incredibly volatile industry, one in which its customers' orders fluctuate wildly. Perhaps it is in the process of restructuring and can't precisely estimate its cost savings. Or maybe they just can't do simple math.
Whatever the case, a history of missed expectations is a huge red flag to me. And with so many good companies out there that aren't missing earnings, why bother with businesses that don't seem to have a good handle on where they are going?
Companies Missing Earnings
Second-quarter earnings reports were mixed, but better than a lot of analysts predicted. Many companies are beginning to see the proverbial light at the end of the tunnel, but others are not so lucky. I reviewed companies that missed earnings for the last four quarters, and I found the following small-cap companies who not only have consistently missed analysts' forecasts for much of this period, but also boast lackluster fundamental and technical parameters.
They wouldn't be the stocks for me, right now, and if you own any of the following companies, you might reconsider your investments:
- TIB Financial Corp. (TIBB)
- Premiere Global Services (PGI)
- IXYS Corp. (IXYS)
- Hardinge (HDNG)
- Collectors Universe (CLCT)
- Thomas Weisel Partners Group (TWPG)
Red Flag #2: Too Much and Expanding Debt
This is one of the simplest ways to judge if a stock is worth your hard-earned money, yet, a thorough review of company debt is often ignored by investors–to their peril. That's too bad, because the analysis of debt is very simple and doesn't require any special investment knowledge.
Instead, you can find out if a company is utilizing its debt properly with just a few basic questions:
- How much debt does the company have?
- Is it growing?
- Are they increasing their earnings by utilizing the debt, or has their expanded debt decreased their income?
First of all, you must recognize that all debt is not bad–contrary to what you may have heard from the talking heads on TV. Without debt, many great businesses would never have gotten off the ground floor.
Think of it like you would your own debt status. Most of us could not purchase a home without taking on a mortgage. Yet, not counting the past couple of years of falling housing prices, our mortgage loans have bought us an increasing asset, one that historically has risen in value approximately 5% per year.
Or, with the average cost of a college education around $20,000, most families need to borrow money to make their children's higher education dreams come true. And, in most cases, the investment in that degree will pay off for decades to come (although it may seem to most parents that day may not come soon enough!).
With corporations, debt serves the same purpose. It allows a company to grab opportunities to make extra money, including expanding their product lines, purchasing other businesses or making investments to update their equipment.
But sometimes, companies–just like individuals–overdo the debt. Their plans are too rosy, and the debt they take on not only does not add to their income but becomes a noose around their neck, often creating a deepening hole of borrowing money to repay borrowed money. Before you know it, they are in big trouble, especially in a weak economy when easy credit disappears. The first thing to go will be their earnings, and then the price of their stock.
Consequently, if the company you are investigating is not managing debt properly, run–don't walk–away from it.
Companies With Debt Problems
It's important to compare your company's debt load, not only against its history, but also its competition. And with the economy still undergoing significant challenges, I think that businesses that are carrying an overload of leverage should be avoided.
Here are a few companies that have significantly high debt ratios for their sectors, and whose other fundamentals and technical factors just don't stack up to the competition right now:
- Alliance Health Care (AIQ)
- Perfumania Holdings (PERF)
- American Community Properties (APO)
Red Flag #3: Bleeding Cash
I'm sure you've heard the saying, "Cash is king." Believe it. I'll use the personal comparison once again. Think of your individual situation. If you have cash, you have the money to 1) buy the things you want or need; 2) pay your debts; or 3) save more of it for future needs.
It's the same for a company. If they consistently generate cash, that puts them in an enviable position. When times get tough (like the last couple of years), they have a cushion to get them through the worst spots.
But cash brings opportunities, too. During economic recessions, companies without adequate cash may not survive. When they go up on the auction block, guess who is ready to buy them? Yep, the businesses with the cash.
Now, you need to know that corporate cash on a balance sheet is similar to the cash you carry in your pockets. Some days you have a few extra bucks, and other days you are looking under the car seat to pay your freeway toll. Most companies do try to keep their cash accounts solidly in the black for their reporting days (at the end of a quarter or year), but know that I don't worry too much about little fluctuations in that account.
What really concerns me is 1) when a company does not have a reasonable amount of cash on hand, but even more importantly, 2) when the operating cash flow account (you can find it on a company's Statement of Cash Flows) is negative and trending downward.
Operating cash flow is simply a tally of the amount of cash a company generates from its primary business. If it makes bicycles, the cash it takes in from selling those bikes is added to operating cash flow. That's what makes it so valuable to look at. Unlike overall earnings, operating cash flow does not include money that comes from investments, real estate, borrowing or anywhere else. It is the money made by the businesses' operations.
Now, you do have to be careful with seasonal or cyclical businesses. For instance, an amusement park operator in Ohio probably won't have positive cash flow during the first quarter of the year, as it's a little too cold to ride roller coasters in January. So, it's smarter to look at operating cash flow over time–not just one quarter.
You don't want to see too many quarters in the red. In that event, I don't waste any more of my time. Chances are it's a stock to avoid.
Companies With Cash Problems
There are many reasons for declining cash flow: rising R&D costs that haven't yet discovered a profitable product; an industry like tech in which obsolescence and continued hefty R&D investment is mandatory; challenging economic periods in which money coming in drops significantly; and just bad business decisions.
Whatever the reason, it's definitely not a good sign, and companies bleeding cash should be avoided like the plague. Here are just a few cash-challenged stocks that I recommend you stay away from right now:
- OccuLogix (TEAR)
- TranS1 (TSON)
- Oculus Innovative Sciences (OCLS)
- Jamba (JMBA)
Red Flag #4: Cutting Dividends
No doubt about it, it's been a trying time for companies that pay dividends–as well as the investors who buy their shares. For the first time since the S&P began keeping track of dividends in 1955, dividend cuts outnumbered increases during the first quarter of 2009.
Investors lost some $77 billion in dividends when 367 companies out of the 7,000 that the S&P tracks reduced their payments. That's more than quadruple the 83 companies that cut their dividends in the first quarter of 2008. Not confined to poorly run, small-cap companies, that group included "blue-chips" Bank of America, Citigroup, Pfizer, Alcoa and GE.
The primary reason a company slashes its dividends is that it needs money, and badly. Generally, the business is in the throes of unexpected financial events that will severely affect its earnings–current or future.
And boy, those circumstances fit the bill this year, didn't they?
Granted, the current economy and the resulting financial pressure on companies has been unusual, so it's a little more difficult to separate the dividend-cutters who were merely trying to nip short-term problems in the bud from those in which the dividend cut is but the first warning of what's to come.
Consequently, it's up to us to figure out why the cut was made and whether it signifies just temporary or long-term challenges for the company.
To do that, you will have to put on your investigator's hat. First, think about the explanation that management gave for the cut–does it make sense?
Next, look at the company's cash position. Does it typically run pretty lean? Has it been decreasing over time to an untenable level?
And finally, review the earnings trend, again, over a period of a few years. Are they trending down, or not growing as much as their industry warrants?
In general, a cut in dividends is not a lightning bolt from the sky. Instead, it's a continuation of bad news that will first show up in cash and earnings.
Dividend-Cutters to Avoid
It should be no surprise to you that most of the dividend cuts came from financial companies. In fact, in the first month or so of 2009, 35 of the 41 companies who slashed their dividends were financials. And many of those firms continue to face significant challenges, including a need to shore up their capital cushions and repay TARP funds, before they can get back to business as usual.
Therefore, I've taken them off my list of potential stocks to buy. I'll wait to see signs of recovery before I risk my money.
I've been carefully researching financial stocks, as having worked in the industry my whole life I have a soft spot for them. But I haven't found any just yet that look like pressing buys for us here in Buried Treasures. In fact, my favorite sector–small-cap banks–was hit really hard with dividend cuts in the last year.
I took the poor economy into account when I began my analysis of the sector and tried to not penalize the companies too much for their dividend slashes. But in many cases, the dividend cut was just a symptom of much greater problems, including continued dependence on federal bailout money, a need for further capital infusions and significant (and growing!) loan losses.
After eliminating the banks that I think will speedily recover, here are ones that I would definitely stay away from at this time:
- American River Bankshares (AMRB)
- Cadence Financial Corp. (CADE)
- Cascade Financial Corp. (CASB)
- Central Pacific Financial (CPF)
- FNB United Corp. (FNBN)
- MBT Financial (MBTF)
- Preferred Bank (PFBC)
Red Flag #5: Lots of Promise, but No Results
Companies are founded on ideas and hopes, and the reality is that many just don't survive. Unfortunately, there is no magic formula to determine which incubator businesses will succeed and which will fail. When Bill Gates and Paul Allen started Microsoft back in 1975, few could have imagined the heights to which they would eventually climb.
But most companies never make it that far. Many will do well; some will trudge along, barely making ends meet; and others will not survive. According to BankruptcyData.com, last year, 136 publicly traded businesses with $1.6 trillion in assets filed for bankruptcy. And in the first quarter of 2009, 44 more bit the dust–more than double the number in first quarter 2008–risking more than $100 million of their assets.
True, the last couple of years have been much worse than normal, and we are not yet out of the woods. We all need to be extra cautious in this economic climate in determining if the companies in which we are invested have what it takes to remain going.
As I said, coming to this conclusion is not black and white. However, there are certain warning signs that will give you a good indication of a company's challenges, as well as its survival potential.
Betting it all on one product. The majority of companies–at inception–do have just one product or service. But, over time, most will expand their offerings, either by design or by accident. That not only brings additional revenue sources into their coffers but helps to diversify their business should one or more product lines experience a setback.
While I tend to veer away from conglomerates that have dozens or more subsidiaries in different sectors, I like to invest in companies that offer some diversification–and investor protection–should one of its business segments suffer temporary adversity.
Companies dependent on outside funding. While most biotechs and pharma companies go into the business hoping to create the next blockbuster drug, very few actually succeed, especially in an uncertain economy. Their R&D efforts require tremendous cash, and during tough economic times, the deep pockets of venture capital funding dry up.
Additionally, it's often a crap shoot, obtaining FDA approval through a series of drug trials that can last years. And in most cases, there's a host of competitors nipping at their heels ready to take advantage of any missteps, such as a failed trial or an FDA order to go back for more R&D.
Now, don't get me wrong. We absolutely need biotech companies, but for most investors, they are just too risky for a strong, long-term portfolio. I recommend that if you just have to have biotech in your holdings, make sure it is a very small portion of your entire funds.
Companies that require continued capital investment. Over the long term, shareholders make spectacular returns by buying businesses that are able to achieve extraordinary returns on capital. This leads to excess capital that the company can use to repurchase shares, pay a dividend to shareholders or reinvest in further growth.
Companies that constantly need to make additional capital investment to keep the business going are the antithesis of this ideal–the main beneficiaries will be employees, management, suppliers and government. Take a look at Coeur d'Alene (NYSE: CDE) and its long-term performance to substantiate this point. In other words, everyone profits except shareholders.
Biotech Stocks to Avoid
I looked for the biotech companies that were severely challenged–in terms of earnings, debt and cash flow. Additionally, I sought out those stocks whose technical indicators predicted that the bad times may continue for a while.
As I mentioned, I recommend keeping any biotech stocks you own a small portion of your overall portfolio to begin with, but here is a short list of the companies that I would recommend you avoid altogether:
- Repros Therapeutics (RPRX)
- Celera Corporation (CRA)
- CardioNet (BEAT)
- Caraco Pharmaceutical Laboratories (CPD)
3 Buried Treasure Stocks to Buy Now
Now that I've helped you spot clunker stocks that don't deserve your cash, I want to show you what a good, cheap stock looks like. In fact, I want to tell you about three stocks that I've recommended my readers at Buried Treasures Under $10 buy today. As you'll see, they not only pass the tests I outlined above with flying colors, they also have smart management, sound fundamentals, and a clear ability to grow because they are benefitting from powerful locked-in trends.
I believe all three stocks can double for us, so even if you don't join us at Buried Treasures Under $10, I urge you to check them out. Of course, when you join my advisory service, you'll get my eagle eye watching these stocks and letting you know when it's time to sell… or buy more shares!
But before I give you the names of those stocks, I want to take just a moment to tell you how I found them. Of course, this is the Reader's Digest version of my stock-picking strategy, but you'll get the idea.
How to Hunt for Hidden Gold
In Buried Treasures Under $10, we want to own companies that are not just surviving but are thriving right now. They may be hard to find, but that's one reason I call them Buried Treasures. I've spent most of my career hunting for these stocks and like nothing better than buying them from right under the noses of Wall Street's analysts–and at extremely attractive prices.
First, I want to find low-priced stocks. We'll stick almost exclusively with stocks trading under $10 whose shares could easily double or even triple. After all, your portfolio needs a fast–but sensible–boost, and it's often easier for a $7.50 stock to move to $15 (or higher) than it is for a $50 stock to climb to $100.
Next, I'm looking for companies with shares trading at reasonable values based on future earnings streams. The problem here is that, in the wake of the bear market, there are now thousands to choose from, so we have to narrow the field down much further.
That's why I only want companies that are financially strong. I especially like those with solid cash flow, low debt, earnings prowess, some Wall Street interest (but not a huge amount – yet!), plus a track record of not merely surviving but prospering in good and bad economic times.
Also, these companies must have a catalyst that will help their stock prices pop. Right now, that could mean they benefit from the economic stimulus package, or they have a new product that makes businesses more efficient or consumers more satisfied, or almost any factor that will draw attention to the company's success and drive the stock price higher.
Fortunately for us, there are a whole bunch of stocks that meet those criteria, too. So how do we uncover the cream of the crop?
Looking beyond the stock screens, annual reports and headlines is critical. "Kicking the tires" of a company that looks promising on paper by touring a facility and getting an up close and personal look at the products, the process and the people is worth it. Personally visiting our potential winners is one of the many services I provide to my subscribers so you get a firsthand analysis of the stocks we're buying.
I pay a lot of attention to "insider trading" – meaning how the CEO, board of directors and executive officers are handling their company shares. These transactions are publicly reported and therefore an essential ingredient of a thorough company evaluation. Ferreting out the trends of buying and selling behavior within the company walls is a key indicator for me. I do the leg work and pass this info along to my subscribers for every stock in our portfolio.
Lastly, I look at institutional ownership – the shares owned by large shareholders – and the patterns of buying and selling that occur coupled with the reasons behind those actions. Often these movements are just another way to identify potential strengths and weaknesses in a company.
In the environment, it all boils down to identifying those companies that are in the right place at the right time to reap the rewards from the recession and the natural tightening of consumers' pocketbooks. I'm finding these stocks for my Buried Treasures Under $10 subscribers, and I want you to profit from them, too.
Here is one stock I'm recommending to my readers now:
Buried Treasure #1: Discount Shopping
Hurt by an economic recession that has spawned a 25-year-high unemployment rate of 9.8 percent and home foreclosures that are estimated to reach 2.4 million this year, shoppers in all economic groups are finding the allure of stretching their dollars at discounters even more attractive.
Whether it be clothing, food or home sundries, every dollar saved is a dollar earned in this environment. And as the latest retail sales figures demonstrate, consumers are drastically changing their shopping patterns.
While Wal-Mart's sales grew higher than analysts' estimates, Thomson Reuters reported that specialty chains like Abercrombie & Fitch saw a 20% sales decline in January, and same-store sales at high-end department store retailer Nordstrom dropped 11.4%.
Whatever you want to call it–the return to basics, aversion to toxic spending, or living within your means–this trend is taking on the characteristics of an avalanche, roaring through consumer buying patterns and creating untold opportunities for a handful of companies (and their investors!)
And discount shopping is just one part of the "savings" trend. With consumers making every penny count, there's one more buying pattern that is ready to take off. And I learned this one at my mother's knee.
With a family of five children and parents earning barely enough to be considered middle class, my mom had to really juggle the household budget. And one area where she saved considerably was the "tomato sauce is tomato sauce" argument. Early marketers like Campbell's and Heinz did a remarkable job selling their labels as superior to private brands. But my smart mom didn't buy the hype, so we grew up on "whatever was the cheapest" when it came to canned and bottled food choices.
Secretly, however, I always wondered if mom was right. But when I grew up to be a securities analyst and began traveling across the country, talking with the CEOs of dozens of companies, visiting their facilities and watching their production lines, you know what? I discovered that Mom–once again–scored! I have seen numerous food processing lines where–once the can was filled–the line split, with one can getting a brand name label and one being marked with a private label. And they had the same ingredients!
As of the end of 2008, private-label had cornered 21.9% of all package-goods categories and retail channels, according to Information Resources Inc. And an even more interesting reflection on the state of the economy is this statistic: In households earning more than $100,000 per year, private-label grew 1.3 points in fourth-quarter 2008, up from a 0.1 point growth in the first quarter.
The Private Label Manufacturing Association reported that sales grew by $5.4 billion last year to a record $74 billion. Here's what it boils down to: One of every five items sold in the U.S. is a store-brand, and those numbers are growing exponentially!
And what it means to you is this: A handful of discounters and private-label manufacturers are on target for staggering boosts to their earnings. The upshot of those results will mean more analysts and institutional investors jumping on board these stocks, providing fabulous opportunities for investors like you to begin rebuilding your portfolios.
Wading through all of the hype to find exactly which companies are set to benefit the most is a time-consuming–and often thankless–task. With scores of companies operating in both the discount and private-label businesses, you could easily spend months trying to ferret out the best opportunities–time that you don't have, because these companies are set to blow past their upcoming earnings estimates right now!
But don't worry–that's what I've been doing for the past few weeks, combing through mounds of financial reports, press releases, and talking to analysts and experts who concentrate on these industries. It's all part of the work I do for my Buried Treasures Under $10 subscribers, as you'll see when you become a Charter subscriber. And from that research, I have winnowed out some real gems. Here is one of my best ideas to take advantage of these mega-trends. But you need to act before it's too late–before Wall Street picks up on this trend and runs the stocks up past my buying points!
Growing Profits Even in a Recession
Discount retailers, private label and home entertainment all become very appealing when dollars are short, and right now, that theory is being proven. Discounters such as Wal-Mart (NYSE: WMT), Big Lots (NYSE: BIG) and the various dollar stores all seeing big sales gains at the expense of brand-name competitors.
The big guy, of course, is Wal-Mart, and although we wouldn't invest in the company because it's trading for more than $50 a share, they fared pretty well during the recession. However, I want to talk about a company that just might knock Wal-Mart off its throne.
Tesco (OTC: TSCDY) is the king of supermarkets in Britain. It's the reigning grocer, and like Wal-Mart, also sells household appliances, equipment, flowers, clothing and electronics. And if that wasn't enough, the company also owns gas stations and financial service firms. Additionally, just like Wal-Mart has done so successfully, Tesco has been a technological pioneer. In fact, I believe that's an area where they have at least one big advantage over Wal-Mart.
You may recall that online groceries were one of those fads that came and mostly went during the wild tech ride of the late '90s. All the Wall Street analysts hyped them to the gills. A few are still around, but they never really became quite the barn-burners they were touted to be–at least not in the U.S.
But it's a different story in Europe, and with Tesco. In 1994–long before Facebook, Internet gaming and IM–most folks weren't even using email on a regular basis. Tesco, however, decided the time was right to step into a virtually unknown part of the retailing marketplace–online groceries.
And wow, has it ever paid off!
Today, Tesco is not only the #1 retailer in the U.K. (with 34% of the market) and the globe's third-largest retailer overall, but the company is the #1 online grocery retailer in the world! And yes, it makes money from its online operations.
But best of all, Tesco's Chief Executive Terry Leahy said the company was "well-placed for a global recovery" and that the worst of the U.K. recession was over.
Buried Treasure #2: Cheap Entertainment
Another fact of life in a recession: People spend more time at home–what the marketers call "nesting." And if you're like me, whenever I am in more than out, I'm searching for something to keep me busy, to entertain me, or a home improvement project (commonly known as a "honey-do" list).
But with so many folks skimping these days, renovation projects aren't on the budget and are taking a back seat to cheap entertainment.
Instead of dining out at a fine restaurant, 43% of respondents to a Booz & Company survey said they are cooking more often at home. 27% are increasing their entertaining at home, 27% are watching more television and 25% are surfing the net more.
And if you are looking for more than a meal to keep you cocooning happily at home, you need to look no further than home entertainment software. As I said earlier, this sector is a booming business.
Last year, according to the Consumer Electronics Association, Nintendo sold more than 10 million of the popular Wii gaming systems. I didn't quite grasp the concept until I recently visited my best friend in Florida. She aptly demonstrated all the fun ways to exercise without realizing you are actually working at it. No wonder sales are going through the roof!
As reported by NPD, gaming software and hardware, alone, grew to a record $5.3 billion. And already in 2009, the gaming industry saw a 13% increase. The industry explains the appeal by saying that while a restaurant meal for a family of four can cost around $100, a $60 video game can entertain the family for weeks. Makes sense to me.
Another growing electronic category–e-books–were great products for retailers, who, even in a dismal sales climate, saw 540,000 e-books go out the door in 2008–a figure that is predicted to double this year.
And sales of laptop computers soared 21% last year. 5% of that growth was attributed to netbooks, low-priced lightweight laptops mostly used for web surfing.
This One's "Game" for Take-Off!
I should have probably asked my nephew, Mason, to write about Activision Blizzard (NASDAQ: ATVI). As an avid video game player, he could certainly shed much more light on the detailed technology that makes this company's games so popular. But don't worry. You'll hear more from my "gaming" expert in the upcoming issue of Buried Treasures. Receive your copy of the next issue ofBuried Treasures Under $10 when you sign up for your charter subscription today.
For now, let me tell you about the two good catalysts that I think will move the stock higher: 1) The recession has made stay-at-home entertainment a lot more enticing (it's cheaper!), and even adults are joining their kids in playing some of the most popular video games; and 2) the video game business is growing at double-digit rates.
ATVI is the cream-of-the-crop. Last year, four of the top 10 best-selling video games in the world belonged to Activision, including Guitar Hero: On Tour, the #1 title in dollars on the Nintendo DS. And its Guitar Hero III: Legends of Rock version was the first video game to ever pass $1 billion in sales from just a single title!
In short, Activision has created a tremendous catalog of games, constantly expanding its game titles–as well as its technology–and the company is now the #1 console, handheld and PC game publisher in the U.S. and Europe.
And while the industry is expanding phenomenally, Activision is handily outpacing its competition, racking up 30%+ annual growth in the past five years. The company's financials are impressive:
- Record sales and earnings, consistently beating analysts' estimates.
- No debt.
- Nearly $3 billion in cash.
Also important, Activision's insiders have been on a stock-buying spree, currently staking a claim to about 55% of outstanding shares. I have found heavy insider buying to be a very reliable sign that a stock is about to take off.
Institutions are also beginning to take notice, but at the moment, they own just a minimal amount of the shares. That's why now is the time to buy, before they get seriously interested and run up the price of the stock. Don't miss out! Learn more about this stock and other companies like it when you join Buried Treasures today.
Buried Treasure #3: Double- and Triple-Digit Growth
My addiction to Cheez-Its is well-known in my family, but I'm certainly not alone. The 2009 State of the Snack Industry report (there's a report for everything, huh?) concluded that, although we've been in the midst of a recession, snacking is alive and well.
After declining in most of 2007 and into the first quarter of 2008, snack food purchases actually rose by 1.1% in the fourth quarter of last year. And the U.S.' hunger for junk is spreading its tentacles across the world, as other nations adapt to our "too busy for family meals" lifestyle. Global Industry Analysts (GIA) predicts a worldwide snack food industry of nearly $300 billion by next year, with most of the growth coming in Asia Pacific, Latin American and Eastern European nations.
Three main factors are driving this impressive growth:
- Product innovation. Have you looked at the cracker aisle in your local grocer recently? Even the most mundane of crackers–Triscuits–now offers several varieties. The industry calls this a "premiumization," which in English means, "We can charge more!"
- The rise of healthier snacks. Yogurt-covered everything; fruit-filled oatmeal bars; chicken snack wraps; a variety of salads, even at fast-food restaurants; veggie chips; seaweed snacks; bottled smoothies; and on and on. According to the International Snack Food Association, 79% of the 1,100 new products introduced last year were labeled with some type of health benefit claim.
- Private-label volume has increased 8%, and dollar sales rose 6%, according to Information Resources Inc. (IRI). Sometimes a green bean is just a green bean–or in this case, a bag of cheese popcorn!
To make our money, we want to turn to the largest segment of the snack food industry, which is called "salty snacks" and makes up about 40% of the snack market. Sales of these goodies rose by a solid 7% last year and are expected to grow to $21 billion by 2013, according to Mintel International. This is another industry that is thriving during the recession as people stay at home more (how about some popcorn while watching a DVD or playing that video game?) and calm their worries, at least temporarily, with a tasty comfort snack.
Bottom line: Snacks are a growing industry, and I've found a stock that I think is ready to, well, pop!
A Small and Growing Buried Treasure
You know all the big snack players, including Frito-Lay, Procter & Gamble, General Mills and Kraft. But the snack food sector–like most other sectors–is home to hundreds of smaller companies. Find the right one, and you can make a lot more than investing in those behemoths.
I believe that is what will happen with Inventure Group (NASDAQ: SNAK).
SNAK (you have to love the symbol, don't you?) makes a variety of, you guessed it, snacks! They include T.G.I. Friday's and Burger King brand snacks (under license agreements with each company), and it manufactures its own brands including Poore Brothers, Bob's Texas Style, and Boulder Canyon Natural Foods batch-fried potato chips, Tato Skins potato snacks and O'Boise potato snacks. Each of its lines offers a wide variety of flavors, resulting in more than 50 total products.
SNAK also makes private-label snacks for grocery, natural food stores, and other retail chains and distributes snack food products manufactured by others in its home state of Arizona. Lastly, the company's Rader Farms division grows and markets berry blends, raspberries, blueberries, and rhubarb, as well as resells marionberries, cherries, cranberries, strawberries, and other fruits to wholesale customers in the United States.
SNAK's products are sold directly to mass merchandisers, grocery, and club and drug stores (like Albertson's, Safeway, Kroger, Wal-Mart, Sam's Club and Costco), and to convenience stores and vending operators through independent distributors.
Double- and Triple-Digit Growth in a Recession
While SNAK is certainly a competitor of some of the large snack manufacturers, it chooses to bill its niche brands as a "complement" to the offerings from its larger peers, and is actively pursuing its goal to build brands with annual sales of $5 million to $50 million by licensing, acquisition or development.
As growth continues, the company is actively seeking to add capacity. It has 200,000 square feet at its production facilities in Indiana and Arizona, with manufacturing capacity capable of supporting up to $150 million at wholesale. Currently, these facilities are operating at 40% and 50%, respectively.
Inventure is also spending $1.5 million on expansion and efficiency improvements, including high-capacity kettle cooking equipment, high-speed packaging machines and automated case packing lines at its Arizona facility, due to be completed by the end of next month. That sounds like it may be expecting some interesting contracts soon!
Inventure is definitely making money. SNAK's second-quarter revenues were up 14.3%, to $33.4 million, with good growth across the board. Sales in the healthy/natural category were up 20%. That's great, but the company's dedicated focus on its private label business really paid off, with sales increasing by a stunning 155%!
That helped gross profit margins rise to 19%, compared with 18.1% in the same quarter last year, which drove net income up to $1.03 million, or $0.06 per share.
As you can see, SNAK is proving itself to be much more than a survivor, and now Wall Street is sitting up and taking notice in two ways: First, analysts have raised the company's earnings estimates more than once in the past several months; and second, institutions increased their purchases of the company's outstanding shares during the same period.
Now, I want to be very clear about something: SNAK is smaller than our typical stock, so I advised my readers to be patient when buying shares. I deliberately set my buy limit very tight, because I do not want them to chase this stock. It can be volatile, and volume is on the lighter side, but if you are patient and disciplined, you should be able to buy at a sensible price in anticipation of at least a double down the road.
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