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My investing philosophy mostly centers around the Value discipline and GARP- Growth at a Reasonable Price. This blog includes commentary on market conditions as well as fundamental analysis of specific companies. Graduated from Rhodes College with a degree in Business with concentration in Finance & Marketing. Currently working on obtaining the CFA designation. Previously worked in Mortgage Trading for a major bank. Use MS Excel extensively for developing investment models, notably valuation models based on DCF methods.

Monday, November 19, 2007

Book Review:Getting Started in Value Investing by Charles Mizrahi

I just read Charles Mizrahi’s new book, Getting Started in Value Investing just released this month from Wiley Publishers, (amazon book link) and I found it to be phenomenal. I wanted to discuss my views on Value Investing and why I liked the book so much.

Getting Started in Value Investing is a terrific guide for anyone studying the discipline of Value Investing. The text is also an excellent companion for experienced investors as well. The author does a excellent job explaining the Value Investing process. He presents the material in a manner that really helps the reader get in the Value Investing mindset. Regardless of investing experience and knowledge, all investors seeking better results will benefit from reading Charles Mizrahi’s book.

Value Investing is one of the most written about subjects in the finance/investing space. There are dozens of books just covering methods of Warren Buffet specifically, plus dozens of other texts on the value approach. It’s never difficult to find this kind of reading material, yet it can be difficult to discern the truly meaningful content from the vast pool of titles. That being said, there are good number of Value Investing books that pretty much contain the same information thereby conveying same message. At least, that is what I have encountered from reading scores of writings on this subject.

Essentially, after reading many Value Investing guides, I began to have the notion that if I’ve read several, I must have read them all. Yet, When I discovered Getting Started in Value Investing, I quickly recognized that it was no ordinary investing guide. The value methodology and principals remain the same, but the presentation of the material and the manner the author delivers the message is highly effective. Mr. Mizrahi has unique and wonderful writing style that is entertaining and captive, allowing the material to really “sink-in”.

Getting Started in Value Investing is not just another investing book, and it’s not just a beginner’s manual either. It engages the reader, and the flow of information is so well organized that it reads effortlessly. Mizrahi’s examples and illustrative stories train the reader’s mind to think and operate in the Value Investing mental framework. Knowing the principals and methods to Value Investing is rather worthless unless they are properly practiced- when it counts- differentiating the noise from the news, when money is at stake.

I have come across little investment literature that provides level of beneficial information received from reading Mr. Mizrahi’s work. It’s helped shape my thinking- by adopting a stronger focus on value, which I have gained through the text’s memorable examples and pep-talks.

Mr. Mizrahi opens with a quote from Warren Buffet commenting that in 35 years of investing, he has not witnessed a trend towards the value approach. “There seems to be a perverse human characteristic that likes making easy things difficult.” Successful investing is not difficult if one applies the Value principles correctly, along with reducing preventable mistakes as possible. Success is about making more good investment decisions than bad ones. Reading this book explains how Value Investing increases the probability of good decisions and limits the risk of making poor investment decisions.

Getting Started in Value Investing begins with the author stating the book will teach all the methods one needs in order to invest successfully. Yet, he adds a caveat: successful investing will depend on the ability to keep emotions in check as well as avoiding the latest fad on Wall Street. The book demonstrates how to remove emotion and act on the facts.

Getting Started in Value Investing contains all the tools that the reader needs to be an successful Value Investor. Each method is clearly explained, and also demonstrated with effective examples. Mizrahi explains how to analyze firm management, financial statements, competitive position, and how to calculate a stock’s intrinsic value along with applying a margin of safety. These are the tools needed to identify attractive investment opportunities.

My biggest investing weakness is making a trade on emotion without doing the necessary research. When I analyze my poor investment decisions, often the reason is “Just wasn’t thinking.” It just happens, I get caught up in the market noise and act without much thought, or even the realization of what I am doing. Investors must resist being transfixed on the whims and emotions of the market. The Value Investing approach hinges on taking advantage of the Market’s mood swings by purchasing stocks at a considerable discount to true value. A stock price less than its true worth provides a margin of safety. This reduces risk because an investor has more leeway with the accuracy of his/her intrinsic value opinion. For example, if one believes a stock to be worth $50, but in reality, the true value is $40, the investor will still make out all right buying at $30, when unreasonable investor sentiment causes a stock to be undervalued.

It’s very easy to lose sight of the pillars and principals of Value Investing when the market is being testy. Remaining steadfast to the value tenets and not wavering during volatile times can be challenging. This requires the confidence to believe that he/she has the correct view, versus the collective view of investors. Mr. Mizrahi provides motivating insight on how to deal with Mr. Market’s psychosis, and illustrates the mental framework needed to resist succumbing to market distractions.

The hardest part can be pulling the trigger on an undervalued investment even though one has performed extensive and thorough research. Market noise can lead to excessive pessimism of investors causing them to overlook the long-term value of a company. The market can ignore a firm’s strong and honest management, the longevity of the competitive moat, and its solid profitability and return on capital. The Value Investor must determine if those factors are likely to remain intact going forward, which thereby answers whether or not, the excessive pessimism is warranted. Reading this book will teach how to distinguish value plays from value traps.

Who’s right? The Market or the Value Investor? To paraphrase a quote from Ben Graham that Mr. Mizrahi shares in his book: if you base your investment decision on exhaustive research and factual data, then take action regardless if others disagree. The opinion of others doesn’t determine whether you are right or wrong. Your opinion is right because it’s founded on extensive research and judicious reasoning. Reading this book stimulated my thinking and decision process, helping me to be cautious when I haven’t performed necessary research, and aggressive when I have.

It’s much easier for humans to cope with making a bad decision as long as everyone else did as well. A Tough pill to swallow is a poor decision made against the grain. Getting it wrong when everyone else gets it right, evokes considerable emotional distress, as opposed to everyone getting it wrong with nobody getting it right. Those disproportionate emotional/mental pay-offs spawn the herd mentality because it shields us from “Looking Dumb” which is a title for the section addressing that issue in the book.

The author provides anecdotal illustrations of how to think and act in order to invest successfully. I love an example he gives about buying “straw hats in the winter” may appear to be stupid, but combine the low winter price and the Summer demand, and six months later, that stupidity turns into high profitability.

I truly found this book to be an instrumental addition to my library. The writing and explanation are excellent, and the examples and anecdotes are highly illustrative. The book provides the necessary tools and explanation for evaluating investments. In addition, and probably most important, the book succeeds with illustrating the proper mindset and thinking needed to take action. I recommend buying a copy.


Thursday, November 15, 2007

Authentidate (ADAT)- Attractive Speculative Play

Authentidate (nasd:ADAT) is an attractive,speculative play offering massive upside potential with little downside risk. ADAT trades @ near cash with a price / book multiple of 0.8x and has zero debt on its balance sheet. Optimistic expectations stemming from the USPS choosing Authentidate as the sole provider of the electronic postmark (EPM), drove ADAT’s shares to nearly $20 in 2004. As customer adoption has been much slower than expected, revenue traction has been soft causing shares to sink to all-time low price of $0.85. The concept of Authentidate’s product/service offerings has always been solid value proposition, yet support for customer implementation has been rather weak.

Authentidate restructured the company and adopted a new strategy resulting in the August release of its Inscrybe™ web-based platform. Inscrybe simplifies the implementation process, which will lead to increasing customer adoption and a dramatic acceleration in revenue growth. The prospects of accelerating revenue growth coupled with high gross margins make ADAT worth considering as a speculative holding given limited risk for further price deterioration.

Company Description: (from ADAT 10-k)
Authentidate Holding Corp. is a worldwide provider of software and web-based services that enable enterprises and individuals to exchange information securely and conduct trusted business transactions. Our offerings are targeted at enterprises and office professionals, and incorporate security technologies such as electronic signing, identity management, and content authentication to electronically facilitate secure and trusted transactions. In the United States, we also offer our proprietary and patent pending content authentication technology as a web-based service in the form of the United States Postal Service® Electronic Postmark. See
USPS EPM.

New Product: Inscrybe Office
Taken from company press release 8/15/2007-
Inscrybe Office is based on Authentidate's proven Inscrybe suite of capabilities serving the document exchange needs of large enterprises today. The new web-based service combines powerful features, such as electronic signatures, content authentication and trusted time stamps using the United States Postal Service® (USPS) Electronic Postmark (EPM) seal, along with a host of other features that simplify the online exchange of critical and time-sensitive documents. Inscrybe Office is available to anyone with web access, via MyInscrybe.com, a new self-serve portal designed to provide individual users personalized access to Authentidate offerings.

Inscrybe Office, is a user-friendly service designed for business or personal use, to securely and conveniently sign, seal and confirm receipt of important documents over the web. In addition to supporting multiple electronic signatures on the same document, the new service offers senders and recipients the benefits of secure and verifiable online document exchange, with optional features such as acknowledgment of receipt, verification of recipient identity, and audit trails. A user may employ any combination of these optional features to legitimize a document transaction.

Inscrybe Office is ideal for legally binding or compliance-dependent transactions such as business or personal contracts, agreements, closing documents, transcripts, offer letters, prescriptions, authorizations and much more. Inscrybe Office has appeal for professionals and enterprises across a diverse range of industries such as education, financial services, healthcare, legal and real estate.

Business Model:
Authentidate provides security solutions for electronic documents so that legally binding contracts can be signed electronically. Authentidate’s technology verifies each party’s identity, timestamps the documents, and archives them at a 3rd-party retention facility. A “paperless” world falls short due to the requirements for signed, original documents, yet Congress passed the E-sign act in 2000 making electronic signatures legally binding given the specific security requirements are fulfilled.

Here is an example of the advantages to Authentidate’s offerings. To execute a contract, a physical signature must be obtained for an original document. This involves the need to print out a paper copy, sign it, and fed-ex the documents ($30 overnight) to the counterparty. The counterparty then receives the documents, goes to have their signature notarized, and then fed-exs the documents back to the originator In total, the transaction probably takes 2-3 days, several labor hours, and around $60 of shipping overhead.

With Inscrybe™, documents are sent and electronically signed online, thus taking only minutes to complete the whole process. Depending on volume discounts, an EPM only costs .10 to .80, providing huge cost savings from traditional signature methods. Evolution towards a truly “paperless” world is encumbered by the need for physically signed documents, yet Authentidate’s solution eliminates the need for paper copies allowing documents to reach a fully “paperless” state.

Operating Performance History:
Authentidate sold its DocStar and DJS marketing group to focus solely on security solutions. Looking at historical financial statements doesn’t represent an accurate picture of Authentidate’s current operations. For example, income statement found on Yahoo Finance shows sales of $17.5m-2005, $16.5m-2006, and $5m-2007. This figures include revenue from discontinued business segments. Revenues from continuing operations only are illustrated below.

2003: 950
2004: 1250
2005: 2822
2006: 3870
2007: 4998

Sales growth for the past 5 years has averaged 56% per annum. Management declined to give specific guidance, but insinuated that Inscrybe (August release) will accelerate customer adoption and usage rates causing a significant increase in sales growth. Gross margins have historically ranged 60-70%. SG&A expenses have been the primary problem, totaling $16.8m fro FY07. Ostensibly, sales would probably have to reach an annual run-rate of $25m for ADAT to attain profitability.

Limited Downside:
In my opinion, shares of ADAT shouldn’t fall much further due to multiple factors that should provide a price floor. Just looking at the balance sheet, shares almost trade at the value of cash items on the books. ADAT is debt free; liabilities only consist of accounts payable and deferred revenue. ADAT’s market value is roughly equal to net-tangible assets and lower than $1.13 BVPS. I feel these factors should place a limit to further price declines. Taking account of intangible assets, such as product technology, patents, and the USPS contract, a case can be made that ADAT should trade at a higher multiple to book value.

I think the important aspect to recognize is that ADAT, if needed, could sell itself to a larger company at a price, at least equal, but likely higher, than present value. Given the high gross margins for revenue streams, ADAT’s business model could be very attractive to a firm with a more efficient overhead cost structure. A market value of $29.3m and cash of $28m suggests the business model (incl. EPM) can be purchased for a little more than $1 million. If ADAT is unable to achieve a desired revenue run-rate accompanied with needed overhead cost-reductions, I am confident that another firm, with greater resources, could deliver successful results.

Thus, I feel that, just from value derived from the assets, ADAT shares should encounter a support level around its current price. If investors fail to see Authentidate’s value, it’s likely a firm in the related space will. It would be much more costly for a firm to “start from scratch” in duplicating Authentidate’s offerings than to just buy Authentidate itself.

1) $0.81 cash per share
2) $0.84 tangible book value per share
3) $1.13 book value per share
4) EPM contract with USPS
5) Authentication patents
6) Inscrybe web-based platform (incl. customer book)

Revenue Potential:
In the past, there was considerable interest for Authentidate’s product offering, yet the delivery and implantation aspect was more difficult for the customer which impeding adoption. Healthcare related firms have been the primary adopters thus far due to the benefits of processing medical claim documents electronically. To receive reimbursements, patient care services must submit certificates of medical necessity signed by a physician to Medicare or insurance provider.

Doug Guy, SVP at American Home Patient commented about incorporating Authentidate’s solution (ADAT PR 4/23/2007) "We are realizing significant operational efficiencies as a result of deploying the Inscrybe eCMN capabilities in our billing centers and branch locations. Over the past 12 months, we have seen a 65% reduction in turnaround time of documents processed by physician offices through Inscrybe, a significant reduction in unbilled dollars, and a marked improvement in internal document processing throughput. Besides a direct impact on our bottom line, it has improved the service experience for our physician and patient communities."

The market potential is massive. Enormous. The state of Indiana has been using Authentidate’s technology for DMV and court-related documents. In Germany, firms are authenticating electronic invoices for VAT tax compliance standards. The legal, financial, real estate, medical, and likely almost every other industry could benefit from using ADAT’s document security solutions.

The core issue is developing a critical mass of users, since adoption spreads virally. Hence, a user wanting to send documents requires the counterparty to use the technology as well. Think of a fax machine. The first fax machine was useless since it requires another fax machine to receive. Yet, as fax usage increased, more and more people purchased fax machines so they could correspond with those already using fax machines. Thus, adoption rates begin at a slow pace but accelerate quickly resulting in exponential growth.

Outlook:
The attractiveness of speculating on ADAT is that revenue traction could explode in a short time period. ADAT doesn’t face any direct competition; it’s real challenge is developing product awareness so that a critical mass can be attained. The degree of the operating leverage inherent in ADAT’s model (high gross margins) translates into more dollars falling to the bottom line as revenues increase.

In my mind the question will not be “IF” but rather “WHEN” regarding revenue traction. Since Authentidate is unprofitable, it needs to see significant revenue growth sooner than later. It should be evident over the coming 2-3 quarters whether ADAT’s revised strategy and Inscrybe platform is highly successful. I estimate the company has enough cash to fund operations for the next 2.5-3 years. It’s very uncertain if Authentidate will be successful in accomplishing this objective, yet at the current share price, it’s worth taking a gamble.


Tuesday, November 6, 2007

Festival of Stocks #61 at StockTrading ToGo

Check out the great articles included in 61st Festival of Stocks, November 5th 2007
Hosted by Blain Reinkensmeyer at Stock Trading To Go.

I thank Blain for hosting the Festival this week and selecting my article: Apple’s versus Amazon’s valuation.

I Recommend:
Dividend Guy takes us through his valuation of Dividend Stock Wednesday: SNC-Lavalin (CA:SNC)

Editor’s Pick:
George at
Fat Pitch Financials asks Vitaliy Katsenelson, CFA of Contrarian Edge about his new book and investing in an “Interview with Vitaliy Katsenelson, author of Active Value Investing.”

Past editions are archived @ Festival of Stocks homepage.
Submit your blog article to the next edition of festival of stocks using our
carnival submission form.

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