Charles & Colvard Gained 105% Since November and It Is Still Early in the Story

An update on my value idea contest submission from November that just broke through the 100% return barrier as business fundamentals continue to develop favorably

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May 17, 2019
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I'm happy to report that my November 2018Â entry into the GuruFocus Value Idea Contest hit the 100% total return mark. Charles & Colvard is a microcap, deep-value turnaround story that I've been following (and investing in) for years now. After this milestone it seems like an appropriate time for an update.

Charles & Colvard (CTHR, Financial) sells man-made diamonds and jewelry primarily aimed at millennials. The stock hasn't done great for me because executing the turnaround has been taking a long time. Then again, I don't think it has been a very risky investment because it is a debt-free company trading at a discount to the value of inventory, while it also has some cash. On Friday the company held its earnings call and released numbers, and it blasted upwards:

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The quarterly report shows that Charles & Colvard's new strategy is working. The company is growing at a solid pace on a consolidated basis. But if you look at the "new strategy segment" (essentially online sales), it is actually growing at a torrid pace (up 38%) while the legacy business remained steady for the quarter. The online business is quickly overtaking the legacy business, and that is an important inflection point. Over time those numbers are going to drive the consolidated numbers.

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Very encouragingly, net sales are way up. At the same time, costs of goods sold and sales and marketing expenses barely moved up, likely because the company is mainly growing sales of finished jewelry pieces. These items are sold at the highest margins.

Meanwhile, the company's SG&A declined significantly. How often do you see that? Operating leverage is clearly showing up in the numbers. High growth and observable operating leverage is extremely attractive. That's the problem with the fancy Silicon Valley high-flyers. They grow sales like crazy but for some reason, these don't trickle down to the earnings. Well, that's different here.

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The statement of operations is showing 4 cents earnings per share for the quarter. Earnings per share over the last nine months are 10 cents. Keep in mind that the last nine months include Valentine's Day and the holiday season. The upcoming quarters are traditionally weaker for this company.

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It is unlikely that this 4-cent quarter predicts an annualized rate of 20 cents, but it could be close.

With the stock around the $2 mark, this still appears to be a very low-risk point to take an early stake in what may become a substantial company. It is trading at 0.7x book value. That's after a 100% gain since November, by the way. Who says deep value investing doesn't work anymore? It is quite uncommon to find a company that's growing this fast, with operating leverage and a strong balance sheet trading below book value. Especially in this heady market.

The bottom line is this is a no-debt company trading somewhere between 8x to 16x forward earnings that's growing revenue well into the double digits and earnings much, much faster. I continue to view this as a very attractive long-term investment.

The one caveat is that the next two quarters are historically the weakest, and the stock tends to get stronger only as the holidays approach.

Disclosure: Author is long Charles & Colvard.

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