Companies trading at large discounts to their net asset values have an additional decision to make when it comes to allocating their capital. Should they buy back shares, or focus on growing the business? Unless there are debt (or other immediate liability) concerns to worry about, value investors would generally prefer that a company return money to shareholders, as this is a lower risk method for generating a strong return for investors. But should value investors still be interested in a company that trades at a large discount to its net current assets even if management has no intentions of returning cash to shareholders?
This decision cannot be made in isolation, as several other factors play an important role in this determination. Investors should consider the nature of the intended investments, the company's ownership/control structure, the level of its management/board ownership, and management's abilities or track record.
For Nu Horizons, these re-investments are not in the form of specialized fixed assets with uncertain returns. Instead, as Nu Horizons is a distributor of electronic components, these re-investments are in the form of inventory. The company is able to generate a gross margin on this inventory, and is currently profitable while simultaneously growing sales, suggesting the investments will earn immediate returns for shareholders.
Often, when management controls a company, it doesn't have to pay attention to shareholder returns and can instead focus on growing the size of its empire, whether shareholders benefit from that or not. In this case, however, management controls just 10% of the votes, leaving the company vulnerable to a takeover if returns are not adequate.
Nevertheless, the company's Chairman and COO own a combined $4.6 million of the company, so they do have a vested interest in seeing the company make decisions that are in the best interests of shareholders.Comments on the conference call confirm that the company is not making this decision to re-invest lightly:
"[Buying back shares is] something we talk about quite fairly, but we discussed it all on a number of occasions particularly in Board meetings, but if you look at the growth that we have in business today and you look at our new facilities that we have that Kurt talked about, then the truth is we are using our facility to fund the growth, which is our belief: that we have to fund the growth... And I think today that’s the right use of our cash. And I understand the concept of buying back stock and as I said, something we discussed on a regular basis."
It's certainly riskier for the value investor when management of a company trading at a large discount to its net current assets chooses to invest in the business rather than return money to shareholders. But under circumstances where management does not control the company's voting direction (and yet has a significant ownership position) and investments are not of a specialized or uncertain nature, a stock may still make for a great value investment. It will be interesting to see how this one turns out!
Disclosure: Author has a long position in shares of NUHC
About the author:
My name is Ben C. and I am 2nd year MBA candidate at the Anderson School of Business at the University of California- Los Angeles. I have a BS in Economics from the Wharton School of Business at the University of Pennsylvania. Before coming to Anderson I worked as a generalist equity research analyst for Right Wall Capital, a long-short equity hedge fund located in New York City. Prior to working at Right Wall I worked as an analyst at Blue Ram Capital, another long-short equity hedge fund located in Rye Brook, NY. This past summer, I worked for West Coast Asset Management as a research analyst. West Coast, which was co-founded by Kinko’s founder Paul Orfalea, is run by well-known value investors Lance Helfert and Atticus Lowe.
Disclaimers: GuruFocus.com is not operated by a broker, a dealer, or a registered investment adviser. Under no circumstances does any information posted on GuruFocus.com represent a recommendation to buy or sell a security. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The gurus may buy and sell securities before and after any particular article and report and information herein is published, with respect to the securities discussed in any article and report posted herein. In no event shall GuruFocus.com be liable to any member, guest or third party for any damages of any kind arising out of the use of any content or other material published or available on GuruFocus.com, or relating to the use of, or inability to use, GuruFocus.com or any content, including, without limitation, any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. The gurus listed in this website are not affiliated with GuruFocus.com, LLC.
Stock quotes provided by InterActive Data. Fundamental company data provided by Morningstar, updated daily.