May 11, 2017 Clifford Cook

In this article, I’ll talk about 3 simple steps that you can follow to implement your value investing strategy and how you can use intrinsic value as a way to determine if a stock is undervalued or overvalued.

Most investors don’t know where to start and how to find stocks that are undervalued.

The easiest way to determine if a stock is undervalued is to calculate its intrinsic value. I’ll dive into this in the Step 2 & 3 below.

Now let’s take a look at each step in turn so you can understand clearly how the value investing strategy works.

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April 12, 2017 Clifford Cook

According to On Death and Dying (New York: Scribner, 1997), the article in which Elisabeth Kubler-Ross introduced the idea of five stages of grief a terminally ill person goes through, there is a range of emotions. They include:

  • Denial
  • Anger
  • Bargaining
  • Depression
  • Acceptance

The progression is similar when an investor holds a stock that only goes lower and lower. Except for disciplined day traders, the first reaction when a stock moves against us in a major way is de­nial.

Of course, the rest of us should take a moment to consider the situation, do our fundamental work, and make an assessment on how likely it is the stock will come back. For sure the stock is un­likely to bounce back fast.

An investor understands this fact and doesn't panic, but once the stock begins to move lower it turns up the emotional heat. You will question yourself and the wisdom of holding a stock when you could simply sell it and buy it back later.

The problem is that people rarely buy back stocks at the levels at which they sold them unless the bottom has totally fallen out of the stock, which would mean the new purchase is a major crapshoot.

The anger part I know all too well. As a provider of independent stock market research, our phones never stop ringing, as more than likely one of our ideas will be against us at any given point. I've seen people hold the worst pieces of garbage for years, but when one of my ideas dips, for even less than a point of a small fractional decline, they go off the deep end.

It is easier to be angry at others than at yourself, but if you could turn that same anger against your own thinking, it could minimize a lot of future angst and potential monetary losses.

I've heard so many investors blame their broker, blame the fund manager, blame distractions, and blame the system for their losses. While there are varying degrees of truth to each of the notions that others caused your losses, in the end most investors who lost a lot of money share some of the blame. They were up at some point during the frenzy and wanted more.

On any given night you could troll the bus depot at Atlantic City and find people with barely enough money to make it back home. I know—I've been there, and the common denominator for many of these poor souls is that they were up at one point; they were winning, but couldn't walk away from the tables or the slot machines.

We all bargain on the inside on what we'd like to do and how we plan on taking our lumps . . . at a higher price. You probably have been in a situation where you've said yes, this investment is a dud and I know it and I'll close it out once the stock gets back to a certain price—as if it's preordained that the stock will make such a move. Plus, if the stock does, many people renege on that bar­gain and change the terms.

Depression in the stock market is a commonplace emotion since March 2000 and it could continue to be for the foreseeable future.

Although I think that as each year goes on, there will be greater traction, eventually the market will break out to a point where there are fewer pitfalls and fewer disasters because investors are fleet-footed and abandon ship so often.

Depression is a serious en­emy of investors; it paralyzes them and leads to any number of mistakes, as people will stick their heads in the sand and wallow in grief.

The fifth step, acceptance, is a key to recovery and moving on. Non-acceptance of a loss means the stock will sit in your portfolio forever, always reminding you of your mistakes and always mak­ing you hesitant to get back into the game.

March 1, 2017 Clifford Cook

Another cautionary tale from a person who should have known better comes from the life story of Warren V. "Pete" Musser, founder and until 2001 chief executive officer of Safeguard Scien­tific. A local business legend in Pennsylvania, Pete Musser began life in the business world as an engineer and then a stockbroker.

He eventually branched out to become a venture capitalist, al­though that term wasn't around back in 1953 when he started the company that was originally called Lancaster Corporation. Two name changes later, the company when public in 1967 and began trading on the NYSE in 1971.

Safeguard has been a holding company that invests in small firms. In the past 10 years the company has invested in or acquired 180 businesses and has been involved in 40 mergers and acquisi­tion exits as well as 24 initial public offerings. The company has been an incubator of companies, and it knew the ropes better than any average investor could. Yet Pete Musser began to buy the shares of other high-tech companies in his own account, and with it began to run up his margin account.

Safeguard shares changed hands very quietly for years and only caught fire after the public learned it was an incubator of small companies and could have a series of hot initial public offerings from its pool of holdings. Throughout the initial excitement Musser was a cool customer, but soon the ghost of Sir Isaac New­ton took position of his soul and it was off to the races.

At Safeguard's peak in 2000, Pete Musser's 8 million shares were worth close to $700 million. I guess any of us would have bought in to the hype, but this is a guy who under­stood business. He understood how nuts the systems was—or maybe he didn't. There was talk of the "new paradigm," when earnings and even sales really didn't matter. I bought in to it for a while, too.

Safeguard shares began to tumble hard. Even though the stock's descent was almost straight down, terra firma didn't come until late 2002. By this time Pete Musser was in terrible financial shape.

Recently Safeguard Scientific settled a class action lawsuit for loans of $10 million and guarantees of $35 million to Musser to help him cover margin calls. In addition, Musser sold 7.5 million of his shares. By all accounts Musser is a great guy, a visionary, and a charismatic figure who got caught in the swirl of hype and promises of endless riches. Perhaps he should have known better. Like Bernie Ebbers, whose defense was that he didn't know what was going on, didn't own a computer, and was a victim of poor business execution, he was in the eye of the storm. If there were such a thing as a bird's-eye view, these guys had it.

In the end, it doesn't matter if you are one of the puppet masters or the greatest mind of your generation. Anyone is capable of suc­cumbing to the thrill of the game and greed. Even when the jig is up, it's typical for investors to hold on to visions of riches and im­ages of grandeur and take the ride all the way down. In fact, some­times the smarter the investor, the bigger the financial hit when the wheels comes off an investment.

Call it arrogance or ego, but as a broker and analyst I've seen doctors lose a lot of money in medical and biotechnology stocks over the years. I think it is partly a factor of doctors feeling like they are the supreme authority in their field (much like Alec Baldwin in Malice). This leaves them vulnerable to making huge mistakes in the stock market. They hear a story, decide the story is great, buy the stock, and go into autopilot mode.

Once they've bought into the potential of a company they're all in, hook, line, and sinker. The same happens to other intellectual professionals, folks whose mental prowess brings home the ba­con. If they have it all figured out, it's tough to get them to un­figure the situation even as the underlying share price of their stock tumbles unabatedly.

During the 1990s I had the toughest time trying to get people who made their living in Silicon Valley to sell any tech stocks. I can still hear the echoes of these brainiacs (and I don't say that in mean-spirited way) saying things like "XYZ can't lose, it makes a blah blah blah that allows for fast transfer of information through a unique blah blah blah." Obviously, back in the 1990s, you didn't have to have a degree in computer science to think you knew everything about tech stocks.

I used to work hours trying to keep up. During the troughs of the tech rally, there were corporate fillings and a ton of other mate­rial to read. Magazines like Red Herring and Business 2.0 were the size of the Manhattan phone article, and it was impossible to stay completely abreast of the newest thing. Yet I would have folks who didn't even know what a company did tell me with unshak­able resolve that their investment was foolproof.

Like the famous song says, "Everybody plays the fool some­time." And if you're in the stock market, you don't begin being foolish until you have totally ignored all the writing on the wall.

Of course, there is always hope and there is always the future, which goes on forever, so in theory any company could "eventu­ally" be a gigantic winner. I've seen a lot of stocks, once left for dead, come back over the past few years, but it still would have been smarter to bite the bullet, rather than waiting for the crash landing.

Swearing Off Stocks

A lot of investors have been bailed out of the negative aspect of sulking this time around because of the unprecedented rally in real estate. However, I think that, just like in the stock mar­ket, most people piled into real estate during the eighth and ninth innings of the boom and a large percentage will be ham­mered. (Although real estate doesn't go "no bid," the probably soft landing was harder than some expected or wanted, espe­cially for those who jumped out of the frying pan of stocks and into the fire of the late-stage real estate rally.)

The point is that while it hasn't received the ink that the housing market has, the equity market was climbing off the canvass, and folks who dumped but bought other stocks that were excessively oversold are doing well and will be doing great over the next couple of years.

Thus far the bounce that began on the eve of the war in Iraq has seen a lot of money being made, but not by a lot of people. If you're saddled with a bunch of nonperformers like Lucent and other former high fliers and are reluctant to buy other stocks until those chestnuts come back, then you've com­pounded the problem. (My son is long in his college fund— I'm happy he's still young, plus there's always state school.)

If you're holding a stock simply out of ego, and the company's margins are falling apart, revenues are decreasing, the product pipeline is drying up, and there are rapid losses of market share, then sell.

That's one piece of the Captain Ahab puzzle. Another piece of the puzzle is being able to bite the bullet and then get back into the game. Sooner or later you are going to either get back into the stock market or at least seriously consider getting back in. If you put through the best periods to be a buyer, then you've shooting yourself in the foot for the second time.

Even if you own a stock that climbed off the canvass from $10 to $15 (a 50 percent move), if your cost is $45, you may have wasted a lot of time and opportunity by not investing in other stocks that aren't merely bouncing with the broad market. (If you have such plays and have been able to create additional holdings, then it's not such a big deal.)

By failing to jettison the old laggards in your portfolio, you create a series of problems, including:

· The emotional toll of looking at huge loses every time you look at your account.

· The financial limitations of not creating cash to find a better in­vestment.

· Wasting time monitoring yesterday's losers when you could dis­cover tomorrow's winners.

February 27, 2017 Clifford Cook

In the classic article Moby Dick by Herman Melville, a wide-eyed whaling ship captain loses his mind and gets everyone on his ship killed (save for one survivor) in a single-minded crusade to kill the magical white whale.

Captain Ahab passes huge pods of whales just to pursue Moby Dick, missing out on riches and in the end crashing and burning. I see this all the time in the stock market. In­vestors simply aren't willing to take a loss on a company that is fractured beyond repair, or should I say beyond any near-term possibilities of repair. I call this obsessive inability to jettison cer­tain stocks the Captain Ahab syndrome.

The Captain Ahab syndrome is all about self-destruction. Maybe it's part of the human makeup; maybe we can't help it un­less we are cognizant that it exists innately. After all, many hu­mans are wired at birth to eventually suffer from an assortment of ailments including cancers, hair loss, and mental illnesses.

In fact, the smartest medical research being done these days isn't focused on cures but on how to detect and lessen or even avoid the impact of this inner programming. We are self-destructive.

We destroy ourselves in the stock market for various reasons, including:

  • The angst over losing money.
  • The hit to the ego at being wrong.
  • The unshakable belief that the wrong stocks will eventually be­come the right stocks.

You aren't stupid; you should not have angst over losing money. You should have a healthy ego, and you have to believe in your in­vestments and the stock market in order to get into the game in the first place. Taking a loss is par for the course in the stock market— at some point we all have to bail out of a stock with a sizable loss. But there is a difference between a big hit, say a loss of 20 percent, and a major hit, say a loss of 50 percent that could have been avoided.

"I can't stand losing money," you say. Welcome to the club. We all hate losing money. But there is absolutely no way you're going to be an investor and not lose money. More often than not, the in­ability to lose money by jumping off one horse, thereby passing up better investment returns from faster horses (those actually head­ing for the finish line), compounds our anxiety.

Still, taking the hit is very tough at times. Just as so-called traders take too many hits, most investors don't take enough hits. I don't want to be cavalier about taking losses, but the sooner you're able to do so without getting emotional, the sooner you'll be on your way to consistently (year over year) making money rather than wasting time pouting, swearing off stocks or a specific stock, and sticking your head in the sand.

"Everybody plays the fool sometimes; there's no exception to the rule ..." You know the song. The late-1990s stock market melt­down from the crashing of technology and telecommunications companies along with the overall market resulted in incredible losses for the public. There are some reports that the losses ex­ceeded $8 trillion.

I'm not sure if the actual amount has been or could ever be accu­rately calculated. It is safe to say that just about everyone got waxed, pure and simple. However, losing money in investments isn't new, and usually the massive losses come from those too- good-to-be-true schemes that have the ability to suck us all in.

One of my favorite articles is Extraordinary Popular Delusions and the Madness of Crowds, by Charles Mackay (New York: Random House Three Rivers Press, 1995). In the article, the author reviews three of the most incredible financial manias of all time, and also examines alchemists, modern prophecies, fortune-telling, the Cru­sades, and witch mania.

The article is a great reminder that schemes and scams have been around from day one and also that everyone can become a victim. When these investment manias blow up, and they always do, small investors like to think they were the in­tended victim from the very beginning, but the truth is, the emo­tion of greed knows no economic boundary, and everyone gets wiped out. Case in point: the so-called South Sea Bubble.

The South Sea Company of England was established to make profitable trades with the Spanish colonies of Peru, Chile, and Mex­ico. The company was formed in 1711 with limited agreements with Spanish officials to conduct trade. This was the time the New World seemed like a marvelous pot of gold—in fact, reports of the gold and other valuables gotten by Spain were irresistible to the cit­izens of England, and even the English government.

The company, along with the government, was actually able to convince holders of short-term government debt of £10 million to exchange it for shares in the South Sea Company. As the years went on, the company was able to gain more government debt in return for shares and outrageously generous incentives until it held £117 million of government debt, versus £3.4 million held by the Bank of England and £3.2 million held by the Dutch East In­dian Company.

The company didn't even make its first voyage until 1717, and it yielded little profit. The fact was that the structure of the company was a one-way ticket for disaster, but the general public over­looked many problems because the hype factor was too good to ignore. There was also the frosty relationship between Spain and England and the actual terms of the deal, which were never clearly articulated to investors.

Still, despite the lack of transparency, folks jumped into the stock, and not just poor, hardworking blacksmiths and shopkeep­ers and regular people, but also aristocrats and a guy named Sir Isaac Newton.

Newton, whose name is still synonymous with in­telligence, wrote the most important document of the Scientific Revolution, "Principia Mathematical". There are stories of Newton actually warning the general public about the risks of buying stock in the South Sea Company, but he eventually took the plunge and made money—the first time.

In fact, this guy who discovered the secrets of gravity doubled his money the first time he jumped in and picked up shares of South Sea. Later Newton picked up the stock again, but this time it wasn't as profitable, as his loss was more than twice the amount he came out with the first time around. I don't think he liked those apples. His losses led Newton to say: "I can calculate the motions of heavenly bodies, but not the madness of people." That was a great comment but something of a cop-out, too.

The best deal the South Sea Company ever got from Spain was the right to supply Spain's colonies with slaves for 30 years; in re­turn, once a year the company could bring in one ship and load it with 500 tons of stuff. There were a couple of strings attached even to this portion of the deal.

The King of Spain would get 25 percent of profits and there was a 5 percent tax on the remaining proceeds. Newton blames the crowd, but it was simply greed that he couldn't calculate or manage.

February 25, 2017 Clifford Cook 1Comment

1. Price to Earnings Ratio

The price/earnings (PE) ratio is the market share price divided by the earnings per share. I find it amazing when analysts can deter­mine whether a company is undervalued or overvalued, based solely on the PE ratio.

As far as I'm concerned, the PE ratio is noth­ing more than a gauge of popularity. If a company has a high PE ratio, it means it's a popular stock and investors are willing to take the risk of owning it.

Somewhere along the way, all PE ratios will come down as growth begins to slow. After all, it is normally sizzling growth and/or the promise of sizzling growth that makes a stock popular to begin with.

Typically stocks with high PE ratios make for good trading vehicles, although in the early stages of a company's growth curve, when it takes off and enjoys a period of uninter­rupted growth, the PE ratio will be well above the industry aver­age and the average of the S&P 500.

Certain industries are known for horrific boom and bust peri­ods, and as a result their PE ratio never gets higher than the S&P 500. The homebuilders are a prime example of that. This is why we compare PE and other ratios against industry averages and not against the broad market.

I like stocks with high PE ratios for in­termediate-term investing. I also like companies with low PE ra­tios that are exhibiting signs of revenue and margin appreciation, but these investments can take longer to work out.

The curious thing about PE ratios is that the higher the ratio, the more forgiving the market, at least when a company stumbles for the first time. However, when a company that already has a low PE ratio stumbles, its share price takes heavy punishment.

This is the case because the company with the low PE ratio has probably already come up short of expectations in the recent past (previous 52 weeks) and there is a stigma in place already.

Remember, the PE ratio is a popularity gauge, and stocks with lower PE ratios have to win back popularity. It takes more than one good quarter to do this.

2. Price to Sales Ratio

Dividing the current share price by revenue per share for the past 12 months provides the price to sales (PS) ratio. This metric is popular with folks trying to get a handle on valuing businesses with fast top-line growth but limited bottom-line results. In the past this metric has been very important when comparing tech­nology companies.

The idea with this metric is that a company with a low price to sales ratio (generally 1.0 or lower) has the potential to rally should the company get its act together and begin to filter revenue down to the bottom line.

This only makes sense. For the most part, like all key valuation metrics, it is believed businesses make mistakes, learn from them, and fix them, and then the valuations of their un­derlying share price will move toward the industry average.

3. Price to Article Ratio

The price to article (PB) ratio is another gauge for measuring the value of a company's shares. To get this ratio you divide the cur­rent share price by article value per share.

In order to determine the article value per share, take the assets on the balance sheet (from the most recently reported quarter) and subtract the liabilities. Then take that difference and divide it into the number of shares outstanding. The result is the article value per share.

This is one of the more popular gauges of value among purists. If a company has a PB under 1.0, it means the stock is changing hands for less than its intrinsic value. The sum of the parts is more valuable than the company.

And this doesn't even take into ac­count intangible assets, which are subtracted out along with liabil­ities. Of course if a company is trading at a PB lower than 1.0, there is a serious problem with credibility—the Street doesn't believe management will right the ship, and there could also be skepti­cism about the true value of assets on the balance sheet.

Nonetheless, when a stock with a PB under 1.0 begins to see improved revenue gains, its share price could come on strong, but it doesn't happen overnight.

4. Price to Cash Flow

We come up with the price to cash flow (PCF) ratio by taking the current share price and dividing it by cash flow per share.

As you already know, cash flow adds back monies taken from the income statement for depreciation and amortization, so this metric is very important for valuing businesses that carry large depreciation costs.

Businesses that see their fortunes move up and down as part of the normal backdrop also benefit from the use of this metric.

5. Valuation Ratio

Some pundits believe stocks fall into cracks and somehow their share prices become marginalized because the crowds have moved on and aren't paying attention. I don't believe that's true. Yes, the crowds have moved on because they're chasing perfor­mance, but there are so many funds and so many investors out there, stocks don't accidentally begin trading at subpar valuation metrics.

At some point the company made a mistake or two and the Street simply walked away. Our goal is to get back in before the Street rekindles its love for these undervalued stocks. The trick is to understand that the herd moves hard and fast, and changing course doesn't happen easily. So you will have to have patience when you buy stocks with seemingly cheap valuations.

Once the worksheet is completed, investors have to dissect the results. On the top line, make sure the revenue growth is organic. Of course companies that are growing revenue fastest are going to be rewarded, but also look at total revenue growth, not just the percentage change. It's a lot easier to double your sales from $100 million to $200 million than from $1 billion to $2 billion.

You aren't necessarily looking for the company with the highest margins but with the growing margins. Ideally you want your in­vestment to have expanding margins, but to be trading at a discount with respect to the various valuation metrics previously outlined.

The Bottom Line

I've said it before and want to reiterate it again: Operating mar­gin is the key. Managing cash isn't easy. Avoiding the temptation to goose earnings results isn't easy. Finding innovative ways to save money isn't easy. When management does these things well, the stock will respond.

February 23, 2017 Clifford Cook

Recent insider trading scandals, poor and biased Wall Street re­search, and other negative events in corporate America have re­sulted in extremely emotional reactions to earnings releases.

All publicly traded companies must file certain forms with the SEC in conjunction with various events. The 8K filing was for years just for general changes at the company, but now that form is the de facto earnings report.

Officially the SEC form 10Q is designed specifically for quarterly earnings. (The fourth-quarter financial results are lumped in with the full-year results in the SEC form 10K.) While there is more detail in the 10Q, it is typically released weeks after the 8K and by that time the damage is done.

To get a company's financials, it is best to go through their web site. I often get to the home page or investor relations by going through Reuters ( or Yahoo! Finance (

Once you're on the company's web site, you will be able to see financial results as a news item or as part of the SEC filings previously mentioned. Keep in mind, when you are reading the financial results as part of a news release, there will be a lot of hype or soothing verbiage to mitigate disappoint­ments and shortcomings.

Investors may look at the same data and not come up with the share management's assessment. However, although companies can spin press releases, companies cannot spin the filings they submit to the SEC.

Most companies have a link to the SEC under their "investor" drop-down menu. There you will find a long list of filings, so make sure to go straight to "quarter results," or if you are looking for the 8K, look for the largest filing; otherwise you could spend a lot of time opening filings that you don't have time to read. I don't want you to be dissuaded from looking under the hood because you feel like you're wasting your time.

We will look at all the aspects of fundamental analysis and regu­larly scheduled financial releases, beginning with analyzing the income statement. Also known as the profit and loss statement (P&L), this report sums up the revenue, costs, expenses, and earn­ings for a company within a specific time period, normally a quar­ter (three months).

There are usually two versions of the income statement or one version with a lot of footnotes to denote the GAAP and non-GAAP aspects of the report. "GAAP" stands for generally ac­cepted accounting principles. This term is used for financial reports that give investors all the data from events that occurred in a specific time frame (again, you want to be on top of your portfo­lio so you will always review the 8K and 10Q and 10K).

These ac­counting principles are determined by the Financial Accounting Standards Board (FASB—I know, it seems like alphabet soup), an independent organization formed in 1973 to establish private sec­tor standards for accounting. The SEC could actually establish its own standards but it recognizes the work of FASB instead. (By the way, when you're talking to an investment professional or trying to impress your friends in your investment club, FASB is pro­nounced "fas-bee.")

Although GAAP numbers are as close to an open kimono as we can come to seeing what occurred financially during a time period, most analysts eschew it for non-GAAP numbers. In fact, I do all of my earnings estimates in non-GAAP form. I know this seems odd in an era when full disclosure and a desire to turn over each rock is what everyone is after.

However, GAAP results include nonrecur­ring events like charges associated with mergers, legal fees, and other one-time events that shouldn't happen again and probably didn't happen in the preceding quarter or the previous year (the most often used comparable period for assessing progress or lack thereof).

Measuring comparable quarters is the best way to gauge the health of the business and management's ability to navigate and execute. Year-ago quarterly periods provide benchmarks, tests, and additional parameters that serve as the backdrop to as­sessing success or failure.

The Bottom Line

Although I prefer the non-GAAP numbers, this doesn't mean you shouldn't be vigilantly looking for frequently occurring, nonrecurring events and expenses. When you are comparing one quarter against another quarter (mostly year over year) you want to compare apples to apples, so one-time hiccups that are supposed to be anomalies are dismissed. But if the company has a lot of these anomalies, then maybe these events shouldn't be dismissed.