How to Buy a Company for the Change in Your Pocket

Benjamin Graham, the father of value investing, introduced a concept known as margin of safety to the lexicon of the financial world. Warren Buffett, a Graham disciple, still uses the term today. Basically, it means that investors should look at the intrinsic value of the company -- or what the entire business would be worth (cash, real estate, equipment and all) if it were sold today. Then, if the company is priced at a discount to that value, well, you've got yourself a pretty good deal.

In order to do this, the investor has to be able to estimate the intrinsic value of the company correctly. Take for example Nam Tai Electronics (NYSE: NTE), a leading supplier of outsourced electrical components.  Consumer electronics makers like Sharp rely on Nam Tai for image sensor modules and other parts that are found in flat-panel televisions, laptops, digital cameras, video games and mobile phones.

NTE was singled out in the March issue of my Half-Priced Stocks newsletter for its bulging bank account. The firm has over $230 million in net cash, but right now the entire company is on sale with a market cap of just $195 million.

In other words, Nam Tai has a negative enterprise value, something you almost never see. And if you snap up the shares now, you get another $240 million or so in receivables, equipment and inventory for free.

But that's not all that makes this an interesting pick...

When I initially profiled Nam Tai, the shares had been pushed all the way below $3 -- an absurd valuation for a company with a tangible book value of more than $7 per share. Since then, that disconnect has narrowed dramatically and the shares jumped more than +50%. But the stock is still being valued for less than the price of a fast-food combo meal, and I think it still has plenty of room to climb. It's not often you find a company trading at about $4.50 per share that has more than $5 per share in cash.

Whenever a company's market cap falls below the cash it has on hand, it's usually because the firm is burning through that cash. But that isn't the case here. Nam Tai has been consistently profitable over the past 20 years, reporting only a handful of quarterly losses. Even under these extraordinarily tough conditions, the firm still generated a positive $13 million in operating cash flows last quarter.

As you might expect, sales remain depressed in this environment. Soft demand for mobile phone accessories, LCD panels, and consumer electronic devices has forced customers like Sharp to cut back on Nam Tai's contract manufacturing services. However, that has more to do with current economic conditions than being a signal that Nam Tai's services are no longer in demand. Once consumer demand for products like mobile phones, digital cameras, and video games picks back up, the firm's factories will be busy again.

In the meantime, management has taken prudent steps to conserve cash until business improves. It made the smart but tough decision to suspend its dividend last year in order to have plenty of ammunition for when the market comes back. And the company isn't just sitting still either -- it's already preparing to meet stronger demand in the days ahead. Right now, the finishing touches are being applied to a new facility north of Shanghai where mobile phone circuitry will soon be rolling off the assembly lines.

Whether global demand is rising or falling, companies that make products like mobile phones and laptop computers will always be in search of suppliers that can deliver the highest quality products for the most competitive price -- and that is exactly what Nam Tai does.

The firm relocated its manufacturing facilities to China long ago to take advantage of lower costs for materials and labor. Today, a highly efficient manufacturing process allows it to sell backbone components like flexible printed circuits at low costs and still earn one of the strongest operating margins in the industry.

Nam Tai is a textbook example of a company that has been beaten up and left for dead. Wall Street is essentially giving away Nam Tai's manufacturing facilities and future cash flows away for free. It's exactly the type of pick that would make Ben Graham and Warren Buffett salivate.

If you remember, back in February I told Investor Update readers that Nam Tai has no business trading below $5 per share. That statement still holds true today. Investors who followed my research in Half-Priced Stocks got a chance to get on board for the +50% ride, but this stock isn't through just yet. Patient investors willing to ride out this downturn could be rewarded handsomely. I have estimated that Nam Tai should be trading at $10. At recent prices, that offers investors the opportunity to generate a +127% gain.

Good Investing!

-- Nathan Slaughter
Chief Investment Strategist
Half-Priced Stocks

A bidder has offered to pay $456,789 for a steak lunch with billionaire investor Warren Buffett, in a charity auction expected to be completed Friday night on eBay Inc's website.

The top bid as of noon EDT in the 10th annual fundraiser remains well short of last year's record $2.11 million paid by Hong Kong-based investor Zhao Danyang.

-- Reuters

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