What’s the Market Missing?

That’s the question we, as small individual investors, always need to ask ourselves when we evaluate a stock. It is my belief that to be a successful investor, we need to do two things

a) Identify “good companies

b) Identify those which are priced wrongly.

I’ll use two examples from previous posts to illustrate this.

Yellow Roadway (yrcw): First step was indentifying it as a “good” company- I saw that even though the company floundered in the last slowdown, over periods of 5 and 10 years they grew very quickly (20% for 5 years, 11% for 10 years). Another thing I noticed was that their operating margin was higher than any other point in the last ten years, even higher than during the last growth-spurt of the US economy. Thats part a, step one, the numerical analysis. Part a, step two is the qualitative analysis. I looked into managements efforts to broaden their offerings to customers by acquirering competitors. They now have perform everything a customer can ask them, any truckload size, length of trip, time to delivery, etc. They also expanded into mainland China, which is growing far faster than the US. I am also encouraged by their move into the non-asset based logistics market through the acquisition of Meridian IQ. Non-asset based companies have higher margins and lower risks than asset based companies, such as Yellow Roadway (look at Expeditors International , expd,for an example) . After doing this research, I was encouraged by their efforts into margin protection during the next slowdown, and into growth oppurtunities via china, meridian.

Now we had to figure out if this was a good time to get in the stock. Yellow Roadway was down 40% from its 2005 peak, due to fears of higher interests rates and an imminent economic slowdown. Both of these factors are definitely concerning. I just thought that all bad news was priced into the stock . The stock, at around 5x cash flow, was trading at a deep discount to its historical average and competitors. In fact, JB Hunt (jbht) was trading at twice the cf multiple of YRCW. There was no reason not to buy at least a partial position of YRCW, with plans to add more when the stock was hit on economic-slowdown fears.

Circle is suggested entry point

Paychex: Part a) Is this a good company? Absolutely. Great, consistent returns over 10, 5, 3, and 1 year periods (rev. growth of 18, 14, 15, 16 per year, respectively). They perform critical services for clients, such as HR outsourcing, payroll, filing neccesary paperwork, managing funds… These definitely are not commodity services, companies, whether they are 3 people or 3,000, only will give this work to trusted, established companies. Paychex has the largest client base in the country, and a retention rate. They are expanding overseas and have goals to growth EPS over 15% over the forseeable future. Since they have such a diverse client base, a slowdown in employment growth wouldn’t significantly hurt them, nothing close to the impact it would have on a Administaff or Manpower. I have confidence that this business will grow and flourish in the future.

So does the market. And thats the problem. The stock trades at 25x cash flow and 30x earnings, which are both significantly higher than competitor ADP. The discount may be warranted, I just don’t know enough about the business to be sure that I’m buying a great company at a great price. Having just one of those two factors isn’t enough, we need both.

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One Response to What’s the Market Missing?

  1. Festival of Stocks #23

    This is my first time hosting or participating in a Blog Carnival (Festival of Stocks).. I just thank God there are no clowns involved. I’m terrified of them. Anyway, on to this week’s interesting submissions from around the blogosphere. Frugal

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