SINLetter - March 2007

Welcome to edition 20 of Suria Investment Newsletter (SINLetter), a free monthly investment newsletter. The objective of this newsletter is to provide you with unbiased initial research and basic facts about individual stocks and other financial instruments so that you can research them further before deciding to add them to your portfolio or not. If you are reading this and are not a subscriber, you can subscribe by going to www.sinletter.com/subscribe.aspx and you will start receiving this newsletter from next month. I have provided relevant links throughout this newsletter, but if you have any questions or comments, feel free to write to me.

Saturday Brunch:

Some subscribers have asked me if I plan to do seminars to discuss ideas and strategies I use to pick stocks. While it is very flattering to hear that folks would want me to do a seminar, I am as much a student of the markets (it is a life-long learning process) as you are and I already share most of my ideas through these newsletters or the blog. I am also not very happy with the format of a seminar, which is usually a one-way flow of information.

I think it would be a great idea to do brunch on alternate Saturdays to share ideas and discuss investments. Many of my most profitable investments have come from talking to people who have told me about products they love or have shared their knowledge of the industries they work in. So if you happen to live in the San Francisco bay area and would like to chow down some food at a Saturday brunch, please drop me an email. Hopefully we can do this in small groups of 6 or 8 people. Please feel free to bring along your friends as everyone will be picking up their own tab. It would also be great to put faces to the names of some subscribers who write to me regularly.

Receive Blog Entries and Trades by Email:

In case you do not receive blog entries by email, you can still subscribe to receive blog entries by email here. I usually tend to write on the blog about once or twice a week and may sometimes post trades on the blog. As I mentioned in the blog entry Portfolio Updates: Diamond Offshore and NEW, I did make some changes to the SINLetter model portfolio by selling some of our put options. Other blog entries posted in February that may be of interest to you include,

Portfolio Performance:

The very put options that hurt our portfolio performance in January, ended up boosting the portfolio in February, helping us post a gain of 2.25% for the month. Gains in ICON plc (ICLR), Alvarion (ALVR), WisdomTree Investments (WSDT.PK) and Mattel (MAT) also helped us outperform all the major indices by over 4% in February. The monthly and "since inception" performance is tabulated below.


Performance Metric Dow S&P 500 Nasdaq SINLetter
February 2007 2.80% 2.18% 1.94% 2.25%
Since Inception (Aug 2005) 15.49% 13.88% 10.06% 87.06%


Our February 2007 pick ICON plc (ICLR) had a great month, registering a gain of 11.5% despite the sell-off in global markets towards the end of February. As expected, ICON reported excellent fourth quarter results with revenue increasing 53.20% to $184.3 million and earnings surging 62.86% to $11.4 million. A few days after sending out the last newsletter, I discovered this outstanding article by Hans Wagner about ICON and since I did not write about ICON in great detail last month, I figured you might find this article useful.

Suntech Power (STP) was registering a gain of more than 50% in the model portfolio right before the sell-off in Chinese stocks and the ensuing carnage of Wall Street on February 27th. The stock dropped 9.33% in a single day and is now registering a gain of 39.8% in the model portfolio. Since nothing has fundamentally changed in Suntech's business, I am going to continue holding it in the model portfolio but would not suggest starting a new position until the Chinese market stabilizes.

Some of our put options did extremely well in February and served their purpose as a hedge against a falling stock market. Thanks to concerns about subprime mortgage lending, our May 2007 put options on the mortgage REIT New Century Financial Corp (NEWQG.X) are now up 447.2%. Incidentally our put options at $19.7 per contract are now trading higher than the actual price of the stock. Because of the massive 50% decline in the price of the stock since the start of 2007, the dividend yield for New Century Financial has jumped to 49.90%, an absurdly high yield that will most likely be cut by the company.

Continued weakness in the housing market as seen by the 17% plunge in new home sales in January also hurt the mortgage lender Countrywide Financial (CFC) and our July 2007 $40 put options on Countrywide Financial (CFCSH.X) are now up 66.67%. Options are highly volatile financial instruments with the possibility of losing your entire investment if used incorrectly. As you may have noticed, I had to sell our March 2007 put options on the Dow Jones Transportation Index (IYTOQ.X) for a steep loss of 76.92% in early February because the market kept rising and the expiration data was getting closer leading to accelerated time decay.

While our pure ETF play, WisdomTree Investments (WSDT.PK) moved into positive territory with a gain of 14.82% gain in February, our other pick in the asset management sector Barclays Bank (BCS) fell 0.73% in February because of bad debt charges in its credit card division and general weakness in the United Kingdom's FTSE 100 index towards the end of the month. Beyond the bad debt charges, the 2006 results for Barclays were impressive with overall income increasing 25%. The company also boosted its dividend by 17% and the dividend yield is now a very attractive 4.5%.

Gold rose steadily throughout February before crashing with the rest of the market on February 27th. Gold closed the month of February at $668 per troy ounce, a gain of $16.10 or 2.47%.

Portfolio Readjustment:

After holding VA Software (LNUX) in our portfolio for over a year, I am going to sell our remaining stake in the company for a gain of 135.52%. I initially bought VA Software at a point when it looked like their enterprise software division was gaining momentum and because I felt that their Slashdot website was worth more than the entire market cap of the company. I was not very happy to learn that management has recently decided to sell off the software division and concentrate only on their media properties. The fiscal third quarter 2007 forecast was also below expectations leading to a sell-off in the stock over the last few days. Instead of holding on to the stock any longer, I am going to use the proceeds from the sale to purchase Ambassadors Group and Medifast.

Diamond Offshore Drilling (DO), which declared a $4 per share special dividend, went ex-dividend on February 12th and the stock dropped 2.69% or $2.18 in response. The special dividend is payable to shareholders on March 1, 2007. I do not take regular dividends or trading costs into account in the SINLetter model portfolio but since this is a special dividend that materially affected the price of the stock, I will be adding this special dividend to the portfolio on March 1st. The portfolio at the end of this newsletter is as of February 28, 2007 and hence I will not include the special dividend in this portfolio but it will be reflected in the online model portfolio on March 1st as a $320 increase in cash.

Ambassadors Group (EPAX) $29.70

While having dinner at a friend's place in February, I mentioned to him how difficult it was to find two good investments for the March newsletter because many of the stocks on my watch list were either expensive or the sectors they belonged to were going through a period of weakness. He suggested that maybe I should make this newsletter a special edition of "Stocks That Almost Made the Cut".

I almost considered taking up his suggestion but then decided to run a stock screen to see if something interesting showed up. While I do not recollect the exact criteria I used for this screen, I was looking for small-cap dividend paying stocks that had reasonable valuations and high profit margins. Amongst the results of this stock screen, I noticed a company that had also shown up when I ran a screen more than a year ago that helped me find the movie theatre chain Marcus (MCS) and the propane supplier Suburban Propane (SPH). Both Marcus and Suburban Propane did very well in 2006 and while I picked up Marcus in January 2006 for my personal portfolio and sold it on 9/26/2006, I did not buy Suburban Propane. Unfortunately I did not feature either stock in the investment newsletter but did write about Marcus on the blog.

The stock that showed up in the screen I ran in January 2006 and once again last week is Ambassadors Group, a Pacific Northwest company that arranges international and domestic travel for students, athletes and professionals. Most of the customers of the company, who are also referred to as "delegates", come from the People To People Ambassadors program established by President Dwight D. Eisenhower in 1956. The company was spun-off from its parent company, Ambassadors International (AMIE), in 2002 and the stock has done extremely well over the last five years, gaining more than 400% since March 2002. This 400% increase was driven by a high rate of growth in revenue and earnings as well as management's commitment to return value to shareholders through a combination of dividends and share buybacks. While the days of hyper growth seem to be coming to an end, the company is still attractively valued as discussed below.

Would you consider a company that ...

  • expects double digit growth in both the top line (sales) and the bottom line (income) in 2007
  • has a profit margin of 34.45% (for the full year 2006)
  • recently completed a large share buyback
  • pays a dividend (which was increased 35% in 2006)
  • has a solid balance sheet with more than twice the amount of assets as liabilities
  • and is selling at 16 times 2007 earnings

... a good investment? If you do, then you should take a closer look at Ambassadors Group. The company expects to grow revenue more than 17% and earnings more than 20% in 2007. It recently completed a $33 million share buyback representing 5.77% of the total shares outstanding and still has $5.4 million left over from a $25 million stock repurchase plan launched in 2006. The company sports a modest dividend yield of 1.5% but when combined with the share buybacks the "payout yield" is significant. To learn more about payout yields, check out this interesting blog post about a new twist on the Dogs of the Dow theory.

As you can see from the website of Ambassadors Group, the company is also actively hiring. If you happened to read the February 2007 edition of SINLetter, you might recollect that I found last month's pick ICON plc (ICLR) because of their hiring activity, which is usually a sign of growth. While researching Ambassadors Group, I was a little concerned by the fact that they posted a loss in the fourth quarter of 2006. I then found out that just like theme parks, their business is cyclical and they post losses in the first quarter and fourth quarter of each year and make their profits in the spring and summer.

This company with a market cap of $617.34 million has $133 million in cash and short-term investments on its balance sheet and negligible debt. It should be noted that $60.7 million of this cash and investments are actually "participant deposits". With a strong balance sheet, excellent growth prospects, reasonable valuation and profit margins that would turn even software companies green with envy, I believe that the prospects of Ambassadors Group are bright in 2007.

Competitors:

It is hard to identify direct public competitors of this company due to the unique nature of its business but you could consider travel companies like Expedia (EXPE), Priceline (PCLN) and the travel arm of American Express (AXP) as competitors of Ambassadors Group.

The Good:

  • Ambassadors Group grew its revenues and income by 17% and 19% respectively in 2006 and expects a similar rate of growth in 2007.

  • The profit margin for 2006 was 34.45%.

  • Since the beginning of 2007, the company has already deployed $35.5 million to purchase 6.3% of the shares outstanding.

  • The company returned 50% of operating cash flow to shareholders in 2006.

  • Ambassadors Group increased its dividend by 35% in November 2006.

  • As of Feb 1, 2007 the company had 60,600 "delegates" (read customers) enrolled when compared to 47,800 in 2006, representing a 26.78% increase year-over year.

  • Cash balance increased by $24 million and total assets grew 23% in 2006.

The Bad:

  • Gross margins were negatively impacted in 2006 due to higher airfare on account of rising oil prices. Even though oil prices have backed away from their highs, the company does not expect airfares to drop.

  • Operating expenses grew 21% in 2006 but a large part of that was because of marketing initiatives aimed at increasing sales in 2007.

  • The tax rate for 2007 will increase when compared to 2006 because the company used tax exempt investments in 2006.

  • Capital expenditures are likely to increase in 2007 because of a new building project that the company has undertaken. Total cost of this project is projected to be about $20 million, of which $7.5 million was expended in 2006.

  • The company is currently seeing a 30% withdrawal rate amongst its enrolled delegates. Such a high rate of attrition would be a sign of trouble at companies that provide satellite radio, phone or cable services but according to Ambassadors Group this rate of withdrawal is to be expected since delegates often make plans more than a year in advance.

The Numbers:


P/S 8.06 Cash and Investments $133.1 million
P/E 23.80 Long Term Debt $0.196 million

 

Medifast (MED) $8.52

Instead of featuring another new stock this month, I figured I would write about a stock that is already in the model portfolio and that I have wanted to revisit for quite some time now. Medifast is a weight management company that I first came across in 2003 when someone I knew asked me about the stock after it had run up from 50 cents all the way to $15 per share, a 2,900% gain. She told me that she used their products and they seemed to be very effective. I checked out the stock and decided to stay away not only because of the tremendous run-up but also because of large insider sales.

However I continued to follow the stock closely as it started a downward slide that lasted for more than a year and I finally started a position in Medifast in April 2005 when the stock was trading at $3.25 per share. After I launched SINLetter in August 2005, I decided to feature Medifast in the December 2005 edition of SINLetter. After some initial weakness, the stock took off like a rocket over the next seven months posting gains of 244% by August 2006 as you can see from this blog post. The company was exhibiting tremendous sales and income growth. I continued to monitor the stock closely and posted highlights from the Q4 2005, Q1 2006 and Q2 2006 conference calls on the SINLetter blog.

There was a lot of euphoria surrounding the stock and while I believed in the long-term prospects of the company, I took some profits off the table in June 2006 and once again in July 2006 on valuation concerns and high insider selling. These sales generated gains of 233.95% and 231.54% respectively and were instrumental in helping the SINLetter model portfolio outperform the indices by a wide margin in 2006. Since hitting a high of over $21 in June 2006, the stock lost more than half of its value after concerns about its valuation surfaced amid a couple of negative articles by Stocklemon.com and Barron's. Medifast actually went on to write a response to the Barron's article but that did not help arrest the slide in the stock price.

The company continued to execute well and after the release of third quarter 2006 earnings in November, the stock started moving back up only to be hit once again by another article in Barron's that eventually lead to a management shake up at Medifast.

Based on a recent upward revision in their 2006 guidance, the company is expected to post an 83% increase in revenue and based on my calculations between 80 to 100% growth in earnings. The company has a current P/E of 21.09, a forward P/E of 15.78 and PEG of 0.75. I believe that the stock is undervalued at this point and well positioned to move up in the coming weeks. Please note that this stock is highly volatile with wild price swings as discussed above. If the forecast for 2007 or 2006 earnings are below expectations, the stock could decline further.

I am going to double our position in Medifast in the model portfolio by adding another 500 shares at $8.52. Instead of displaying this as a separate line item in the portfolio, I am going to combine it with our existing position and move our cost basis up to $6.955 per share (($5.39 + $8.52)/2). This will unfortunately make it appear like our position in Medifast is up only 22.50% instead of 58.07%.

Every month we add the two featured stocks into a model portfolio started with a cash position of $100,000 on August 2, 2005. To keep calculations simple, trading costs and regular dividends are not included. Prices reflect the closing price as of the last trading day of the previous month (February 28, 2007 for the March 2007 newsletter).

Model Portfolio - February 28, 2007

Stocks

Stock Number of Shares Cost Current Value Diff ($) Diff (%) Date Added
EPAX 300@29.70/share $8,910 $8,910 $0 0% 2/28/2007
ICLR 250@37.30/share $9,325 $10,398 $1,072 11.5% 1/31/2007
DO 80@76.65/share $6,132 $6,226 $94 1.53% 1/3/2007
ALVR 1000@6.87/share $6,870 $7,780 $910 13.25% 1/3/2007
WSDT.PK 1000@7.40/share $7,400 $8,210 $810 10.25% 11/30/2006
BCS 200@54.06/share $10,812 $11,712 $900 8.32% 11/30/2006
SNDK 200@48.10/share $9,620 $7,284 -$2,336 -24.28 % 10/31/2006
MAT 600@19.70/share $11,820 $15,606 $3,786 32.03% 9/30/2006
TEVA 300@35.05/share $10,515 $10,668 $153 1.46% 9/1/2006
STP 400@25.93/share $10,372 $14,500 $4,128 39.8% 7/31/2006
INTC 550@19.00/share $10,450 $10,923 $473 4.53% 6/30/2006
PG 180@55.60/share $10,008 $11,428 $1,420 14.19% 6/30/2006
LOGI 240@20.385/share $4,893 $6,276 $1,382 28.25% 5/31/2006
JNJ 200@57.65/share $11,530 $12,586 $1,056 9.16% 2/28/2006
MED 1000@6.955/share $6,955 $8,520 $1,565 22.50% 11/30/2005
TTM 900@11.94/share $10,746 $16,659 $5,913 55.03% 11/30/2005
AIRN 1700@5.62/share $9,554 $7,718 -$1,836 -19.22% 8/1/2005


Options

Option Number of Units Cost Current Value Diff ($) Diff (%) Date Added
CFCSH.X 8@2.46/contract $1,968 $3,280 $1,312 66.67% 1/3/2007
NEWQG.X 2@3.60/contract $720 $3,940 $3,220 447.22% 10/31/2006
LRXMJ.X 3@7.00/contract $2,100 $1,170 -$930 -44.29% 10/31/2006
YBQMG.X 8@2.60/contract $2,080 $1,040 -$1,040 -50% 10/31/2006
Cash     $2,224      
Total     $187,056 $87,056 87.06%  

 

Voluntary Disclosure: I currently own shares of Airspan Networks (AIRN), Medifast (MED), Tata Motors (TTM), Logitech (LOGI), Intel (INTC), VA Software (LNUX), Suntech Power (STP), Sify (SIFY), Teva (TEVA), Mattel (MAT), SanDisk (SNDK) and Alvarion (ALVR).

 


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