Harman International Industries (HAR, Financial) manufactures high-fidelity audio products and electronic systems including digitally integrated infotainment systems for the automotive industry.
Notably in the first quarter, guru Martin Whitman's Third Avenue (Trades, Portfolio) purchased nearly 230,000 shares at around $90 dollars a share. Today those same shares are available for around $76 per share.
Should this price drop scare us off? To answer this question, we need to understand the following:
1. Why did the market recently sell-off these shares?
2. Is HAR a company that will improve the quality of my investment portfolio?
3. Are shares cheap at current levels?
Let’s take a look at each question with some facts.
Why the market sell-off?
The company recently adjusted its 2016 guidance downward. Back in August 2015, the company had guided 2016 at $6.50 per share. Now the company guides to $6.20 per share. Company officials say the reasons for the adjustment included the acquisition of TowerSec being dilutive to earnings by approximately five cents and the remaining 25 cents of the EPS shortfall is related to weakness in the Professional Solutions division.
So what is the company doing to achieve current EPS targets and grow earnings into the future? The company continues to position itself well for the whole “connected car” movement. At the same time, the company has put significant acquisition and restructuring costs behind it and continues to focus on future partnerships to grow into the future.
Does Harman have a history of strong fundamentals to maintain the quality of my portfolio?
Of course the quality of the holdings determines the quality of the portfolio. And the goal of my portfolio is to develop positions in companies with a proven track record of wealth creation over time. To assess the quality of a company, among the metrics to review is the growth of book value per share and EPS over time.
I find my F.A.S.T. Graphs subscription to be very valuable to get a visual of data over time. As we can see by the chart below, HAR management has found a way to grow book value per share over the last 20 years.
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
Sales revenue growth over time is another important metric to consider. In the case of HAR, again the data suggests success at growing revenue over time and multiple cycles.
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
Are shares cheap at current levels?
We all want quality merchandise at a discount. In my view, that is currently the situation with HAR -- a quality company likely selling at a discount.
Why do I suggest shares are possibly offered at a discount today? To answer that question, it is reasonable to review a company’s valuation against its own history. This can offer us clues as to when shares are relatively cheap or expensive.
Again F.A.S.T. Graphs is helpful for us to review the relationship between earnings and share price over time.
Have a look at the graphic below. I chose to review company data from the past 10 years. Please note first that the average PE for HAR over the past 10 years has been 21.8X earnings (represented by the blue line). Note also that the current PE is 12.5X earnings.
Another way to view the price to valuation relationship is to consider a company’s valuation at a constant 15X earnings. This “valuation line” is represented by the orange line below. Lastly, the company’s stock price is represented by the black line.
Interesting to note that historically the stock price (black line) tracks to either the company’s own PE ratio (blue line) or 15X valuation (orange line).
Note today that the black line (price) is below the orange and blue lines (value). What an effective way to view the relationship that the share price today seems to be below the value. In this light, the sell-off is viewed as an opportunity, not a fear-creating event.
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
In a nutshell
HAR is a quality company with a track record of growing fundamentals. Third Avenue recently bought at around $93. Today shares are around $76. And when we look at the company’s own historical valuation in the market, the shares are available at a PE lower than usual. If we believe the company can deliver on its future initiatives, this suggests shares are well worth a look at these levels.
