One area of investing strategy I find very interesting is the intersection of bottom-up value investing and other approaches to the stock market: global macro, technical analysis etc. There is tension between all of these different frameworks, but I wonder if there are ways they can be combined to yield an approach to investing that is stronger than the sum of the parts. One small, but perhaps compelling example of such an approach is highlighted by the fascinating recent history of Coffee Holding Co. (JVA, Financial).
JVA is a small New York based coffee distributor. They roast and sell coffee through wholesale, private label, and branded channels. Until about three months ago, JVA was a sleepy micro-cap with a $20 million market capitalization. I think I first came across JVA back in September 2010 due to this post on the excellent Shadowstock blog. JVA had experienced some nice growth in both revenue and profitability in the past few years. They had reduced debt and even put in a small dividend. At the time the stock was also statistically cheap, trading at about 4x EBITDA although cash flows were lumpy due to swings in working capital.
The business is not a great one, with low margins, no moat, and an exposure to commodity price risk (which JVA does attempt to hedge). I think I passed at the time due to the commodity risk and lack of competitive advantage.
But lurking in the background was sector momentum. Investor demand for all things coffee related had started coming out of the market bottom in '09, with stocks like Green Mountain (GMCR, Financial) and Caribou Coffee (CBOU) putting up stunning runs. JVA bumped along with decent operating results, but remained a neglected stock that languished on low volume.
The first big tick upwards came in the middle of March, when JVA released strong results for the quarter ending January 31. The stock jumped from $4.50 to almost $8. On June 9, JVA reported another strong quarter and the stock went parabolic, spiking from $8 to over $30 in a little more than a month. At $30, this one-time ugly duckling was trading at 31X EBITDA and 51X earnings. JVA has since fallen back to the low $20s, but even there it is commanding a rather rich valuation.
What happened? JVA did post some strong operating numbers, but the multiple expansion in the past few months has been enormous. Momentum investors woke up and finally smelled the coffee. Take a look at the trading volumes for JVA in the last two months. JVA had been left out of the coffee stock craze and now has had its time to shine. It also probably helped that JVA’s largest customer is GMCR. What could be better than a momentum stock whose largest customer is another momentum stock?
Looking back, it would have been wise for a value investor analyzing JVA earlier in the year to at least pay heed to the fact that many of the other coffee stocks were on fire. Value investors, especially those interested in the micro and small cap space, often struggle with value traps that lack a catalyst for the market price to converge with intrinsic value. We should have viewed the possibility of momentum investors piling into the then overlooked JVA as a potential value unlocking catalyst.
Of course in employing such a strategy value investors have to be careful to make sure the stock is still selling at a discount to intrinsic value and they are not themselves getting swept up in the momentum fervor. I am not necessarily saying JVA would have been justified as a value investment back in March. Maybe upon further research the risks in JVA from a fundamental perspective should have outweighed the possible catalyst of sector momentum. But sector momentum as a catalyst should have at least been a factor in the investment decision equation.
What do you think about the strategy of value investors taking advantage of momentum by favoring overlooked value stocks in momentum sectors? Any ideas for value stocks in hot sectors?
Elie Rosenberg runs a value investing research website at valueslant.com. Sign up here to get his free value investing ideas and analysis by email and get his free ebook — 16 Ways to Find Undervalued Stocks.
A Sleeping Giant?
JVA is a small New York based coffee distributor. They roast and sell coffee through wholesale, private label, and branded channels. Until about three months ago, JVA was a sleepy micro-cap with a $20 million market capitalization. I think I first came across JVA back in September 2010 due to this post on the excellent Shadowstock blog. JVA had experienced some nice growth in both revenue and profitability in the past few years. They had reduced debt and even put in a small dividend. At the time the stock was also statistically cheap, trading at about 4x EBITDA although cash flows were lumpy due to swings in working capital.
The business is not a great one, with low margins, no moat, and an exposure to commodity price risk (which JVA does attempt to hedge). I think I passed at the time due to the commodity risk and lack of competitive advantage.
But lurking in the background was sector momentum. Investor demand for all things coffee related had started coming out of the market bottom in '09, with stocks like Green Mountain (GMCR, Financial) and Caribou Coffee (CBOU) putting up stunning runs. JVA bumped along with decent operating results, but remained a neglected stock that languished on low volume.
15 Minutes of Fame
The first big tick upwards came in the middle of March, when JVA released strong results for the quarter ending January 31. The stock jumped from $4.50 to almost $8. On June 9, JVA reported another strong quarter and the stock went parabolic, spiking from $8 to over $30 in a little more than a month. At $30, this one-time ugly duckling was trading at 31X EBITDA and 51X earnings. JVA has since fallen back to the low $20s, but even there it is commanding a rather rich valuation.
What happened? JVA did post some strong operating numbers, but the multiple expansion in the past few months has been enormous. Momentum investors woke up and finally smelled the coffee. Take a look at the trading volumes for JVA in the last two months. JVA had been left out of the coffee stock craze and now has had its time to shine. It also probably helped that JVA’s largest customer is GMCR. What could be better than a momentum stock whose largest customer is another momentum stock?
Takeaways
Looking back, it would have been wise for a value investor analyzing JVA earlier in the year to at least pay heed to the fact that many of the other coffee stocks were on fire. Value investors, especially those interested in the micro and small cap space, often struggle with value traps that lack a catalyst for the market price to converge with intrinsic value. We should have viewed the possibility of momentum investors piling into the then overlooked JVA as a potential value unlocking catalyst.
Of course in employing such a strategy value investors have to be careful to make sure the stock is still selling at a discount to intrinsic value and they are not themselves getting swept up in the momentum fervor. I am not necessarily saying JVA would have been justified as a value investment back in March. Maybe upon further research the risks in JVA from a fundamental perspective should have outweighed the possible catalyst of sector momentum. But sector momentum as a catalyst should have at least been a factor in the investment decision equation.
What do you think about the strategy of value investors taking advantage of momentum by favoring overlooked value stocks in momentum sectors? Any ideas for value stocks in hot sectors?
Elie Rosenberg runs a value investing research website at valueslant.com. Sign up here to get his free value investing ideas and analysis by email and get his free ebook — 16 Ways to Find Undervalued Stocks.
