After the last column about Universal Display (U.S. 1, January 23), a friend wrote to ask if OLED was “a good price.” On the day the article was published, OLED opened at $94.71; it closed on February 1 at $104.56, a 10 percent gain in about two weeks. In hindsight, it was an excellent price: any price that is less than the future price is “a good price,” but price moves independently of value.
“Price” is the amount of the last recorded sale. Price has at least three components: utility, confidence in the future, and safety.
Utility is the easiest to measure: what does this investment actually produce? Let’s say you want to buy a used car, and that you plan to keep it for 10,000 miles. And let’s say you have your choice of three cars that are each priced at $1,000, but one car requires you to pay down an additional $500 loan, and one car, you have discovered, has $500 stashed in the trunk. The real cost to you of these three cars is $1,500 for the one with the loan, $1,000, and $500 for the one with the cash in the trunk. Your cost per mile would be 15 cents, 10 cents and 5 cents, so the utility of the third car is clearly superior.
Similarly, some companies are loaded with debt, and some have lots of cash. The net cost of the company is called the Enterprise Value (EV), which is roughly what you would pay to buy the whole company — the market capitalization plus the debt minus the cash. If you sum up the net profits from the most recent four quarters and divide them by the EV, you get a quick idea of the utility of a company: that is, if you owned the whole company, what kind of pay back would you have?
Let’s say the best bank rates are 2 percent and you can buy a company that has a 10 percent return on EV. That would be an easy decision. Owning the company is measurably superior to parking cash in the bank, and you are well compensated for your risk.
Returning to Universal Display, it is terrific company because it generates lots of cash, has no debt, and is profitable, but, if you owned all the stock, the current payback would be about 2 percent. Still, OLED is far superior to many public companies that have no measurable utility at all because they lose fantastic amounts of money. For instance, NOW (ServiceNow), BOX (Box), and SPLK (Slunk) — all tech firms — have in the last four quarters lost $61 million, $147 million, and $302 million, respectively. They are priced at $33 billion, $3 billion, and $17 billion.
Companies that lose money have — in my way of thinking — no utility; they rely on the second component of price: a high confidence in the future. For instance, people who believe that most of the world’s conveyances will be operated by Uber robots, have suggested that Uber go public at a valuation of $120 billion. The future, though, is open to considerable interpretation: much could go wrong for Uber.
On the other hand, much is already going right for Universal Display. OLED has a clearly charted, profitable growth path that is generating cash. My main reservation about unprofitable companies is that, when confidence in the future ebbs, they have no leg to stand on, and their prices decline precipitously.
In the worst markets, the lack of confidence in the future overrides every rational valuation. For instance, in April, 2009, prices were so depressed that you could even buy cash at a discount. A Newark, New Jersey, company called IDT had $1.80 a share in cash and sold for $1 a share. The company lost money, but the price said, “This management will lose ALL of this money.”
The entrepreneur behind IDT had several previous successes, so I bought IDT, which divested assets and raised cash. The price climbed to $23, and IDT spun out CTM Media (now IDWM), which rose from $4 a share to $400 before splitting 10-to-1. In hindsight, IDT was a tremendous bargain, but, at the bottom of the Great Recession, the price of virtually every company was heavily discounted.
The third component of value is safety — that is, physical safety and the rule of law. Despite the United States’ deficit spending — what some have called our country’s “rolling default” — people from all over the world want dollars to buy assets in the U.S. where they can operate relatively freely without worrying that the local strongman is going to take their possessions, their freedom, or their life. The values of the U.S. dollar and of U.S. companies are, to some degree, pegged to actual values like freedom, innovation, transparency, and meritocracy.
Not all countries share these values: there are places where companies report excellent growth and earnings for years, and then abruptly stop reporting –— the companies evaporate, and the American shareholders write angry blogs about their experience and receive no satisfaction.
Whatever cynicism we may have about the bad actors in western countries, our shared values hold our companies and our society together, and that helps create value that affects price.
Price and value are somewhat tenuously connected. Our confidence in the future is affected by automated trading, politics, and what economists call “animal spirits.” Real value, though, is built up over time in complex systems, branding impressions, relationships, protective patents, software, and the vast system that companies create to produce profits. Only after years of creating corporate value does the price trend appear steady and pleasing.
So what is a good price?
For a “perfect company,” a good price means that much of the risk has been removed: the company is profitable, has a pattern of growth, has a competitive advantage, is being acquired by insiders, is not too big to triple in size, and has enough cash to weather the worst market. It may be a higher price than you could have paid last year, but you have less risk because the company has further entrenched its position or developed its products. When you own a “perfect company,” you can sleep at night. Even when the market is getting destroyed, you know your company has cash and customers.
Here is another “perfect company” nomination: TREX is the world’s largest manufacturer of high-performance, wood-alternative decking and railing. Their products last longer than wood and need less maintenance. People seem to like TREX decks and are willing to pay a premium for TREX products. Sales and profits have been rising every year. Some insiders are cashing out, but others are still buying.
TREX had sales of $565 million last year. If each deck has an average materials cost of, say, $5,000, that’s only 113,000 decks world-wide. TREX has plenty of room to grow.
TREX’s price is down to $70 from a recent peak of $84. In the last four quarters, TREX has earned 3.2 percent on its enterprise value of $4 billion.
I think these companies will continue to grow: TREX; OLED; AUUMF (Aumann AG, see U.S. 1, November 7, 2018); NICE (Nice Ltd.), NDCVF (Nordic Semiconductor), SKX (Skechers USA), LASR (NLight), and NVDA (Nvidia). They have a good return on EV, trending growth, positive prospects, and they operate in countries that are committed to reliable reporting.
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