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Henry W. Schacht
Henry W. Schacht

Fundamentals Still Matter

August 18, 2011 | About:

It's 2008 all over again. Clients are calling. Everyone is selling. The arrows (save gold) are all red. Shrill announcers bark about the implosion of world markets and like lemmings we're all supposed to fall in line. After all, it makes no sense to buy stocks. Haven't you heard? There are fears about global growth. And without a rosy economic backdrop, equities are trash. Don't buy them... no, not at any price!

Stocks fall every day they will fall tomorrow. So it's better to sell today. You'll be "right" tomorrow. Is it any wonder in this environment that fundamentals are being ignored? Just get out before the next guy drives the prices of everything lower. Indiscriminate, emotional, and painful.

All my sales in the past 6 months look brilliant. The buys? Moronic. The price drops in my portfolio are disheartening, but it is pretty clear that fundamentals are being ignored on both ends of the spectrum.

Tonight I found myself looking at Zip Cars (ZIP). It's safe to say that I am skeptical about the business model and its prospects. The cars seem to sit around a lot. Perhaps that isn't important. But then again it is a new concept. It's green. And most importantly, it's cool. And besides, depreciation is a non-cash expense (just kidding, the cars are leased). But don't forget about the "zero emission" tax credits.

Despite its "feel good" qualities, Zip has been a real disappointment since its recent IPO. After today's 10% drop, the shares are near an all-time low. Nonetheless, the company still reflects a near $700 million market value. For this, investors get a company that sports nearly $100 million in cash. Proceeds from the IPO, not a result of earnings. After all in the last 6 reported months, the company lost over $11 million on $110 million in revenue.

Be patient, Zip is in its growth phase. Profits will come.

The closest company by market value in my portfolio is decidedly-less-sexy Cato Corp (NYSE:CATO). Regular readers will recognize this value-priced women's retailer. Similar to Zip, Mr. Market thinks Cato is worth around $735 million... well, until tomorrow when he will undoubtedly mark it down again. (See above comment about global growth fears)

Unlike Zip, Cato looks like a real growth company. No carbon credits, just healthy profits. Indeed, also unlike Zip, Cato made money in 2008 ($33m)... and 2009 ($45m)... and 2010 ($57m). How else can you explain the $260 million+ in cash it has on its balance sheet? No IPO proceeds here.

I have issues with Cato's ultra conservative balance sheet, but there are worse problems. (See Zip operating results above.) For those seeking safety, Cato's cash pile equates to over 35% of the company's market value. Oh, and there is no debt. In the last reported quarter (not 6 months) alone, Cato reported over $30 million in profits.

No matter. Cato fell nearly as much as Zip today. Nobody cares about these fundamentals.

Cato isn't the most undervalued company in my portfolio, but comparisons like this are pretty revealing. Before joining the herd, look at the fundamentals of the companies you own. Better yet, do it outside of market hours. It may give you the emotional strength to resist the powerful forces at work in these waves of selling.

Today I received a call from fixed income shop trying to gauge my interest in bonds. The salesman said "I spoke to you a month ago and you weren't interested... what about now?" In other words, you must be feeling like a perfect fool with your equities... care to throw in the towel now?

I felt like giving a rundown of the respective dividend yields in my portfolio, but something told me he wasn't interested. He was pulling an emotional string to make a sale. Cato's rock solid balance sheet helped me resist. It's 3.7% dividend yield (with plenty of room to grow) helped too.

I'm not selling Cato (or any of my other holdings) at these prices. This market will start making distinctions again. I think that will mean vindication for Cato shareholders and further pain for companies like ZIP.

Disclosure: Long Cato.

About the author:

Henry W. Schacht
Henry W. Schacht, CFA is the founder of Schacht Value Investors, an investment management firm serving individuals and institutions. He currently serves as President and Chief Investment Officer. He earned his MBA at the University Of Chicago Graduate School of Business and a BBA in finance from the University of Notre Dame. Mr. Schacht is a member of the Association for Investment Management & Research (AIMR), the Investment Analysts Society of Chicago (IASC), and the National Association of Corporate Directors (NACD).

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