FOOL ON THE HILL
An Investment OpinionBy
Growth Characteristics at a Value Price Warren Gump (TMF Gump)
December 7, 1999
Some people who have followed my writings might be shocked by my article today. I'm going to highlight a traditional value play that 1) is in the technology and telecommunications arena, 2) is reporting red-hot earnings performance, and 3) has been a stellar performer over the past year. For the first three quarters of the year, this company's earnings are up 57% and sales have risen 49%. On top of that, the stock itself is up approximately 45% since the beginning of the year.
I can't find anything negative that would classify this company for a "damaged merchandise" tag, something often found in stocks meeting value criteria. And unlike many of today's market practitioners, I'm not redefining "value" investing in such a way that it represents growth investing in drag. This company's price-to-earnings ratio is only 14x earnings estimates for the current year.
Let me briefly recap and expound:
I've found a technology and telecommunications firm with:
- Solid earnings and excellent earnings growth
- A high return on equity of 22% over the past 12 months
- A superb financial structure with no long-term debt and $2 a share in cash
- No significant blemishes in recent performance
- Five years average historical sales growth of 16% and earnings growth of 70%
- A low P/E of 14x current-year projections
Why does the stock trade at such a low valuation? I honestly can't give you a great reason. The only thing I can come up with is that the company is small and doesn't have much coverage from the Wall Street analyst community. In fact, the First Call consensus earnings estimate for the company is derived from a whopping -- hold on -- one person (and this analyst seems asleep at the switch; estimates haven't been updated since August 30). Despite this limited Street coverage, some people have obviously been finding out about what's going on here, given its substantial price movements so far this year.
I'll stop holding out -- the name of the company is Bel Fuse <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BELFB)") else Response.Write("(Nasdaq: BELFB)") end if %>. Since I can't succinctly paraphrase what the company makes, I'll use the tag line from its press release. Bel Fuse "is involved in the design, manufacture, and sale of products used in networking, telecommunications, high-speed data transmission, automotive, and consumer electronics. Products include magnetics for the high-speed data transmission and telecom markets, fuses, delay lines, and thick film hybrids." Basically, the company makes the guts that are used in all kinds of electronic products. If you're interested in learning more about its product line, check out the company's website.
As mentioned previously, the company has been on a tear of late, with sales and earnings per share up about 50% over the past year. Part of this growth is attributable to the October 1998 acquisition of Lucent Technologies' <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LU)") else Response.Write("(NYSE: LU)") end if %> signal transformer business. Since that purchase is now over a year old, growth will no longer come simply from adding the results from that acquisition to operating performance. The company will have to successfully grow the businesses it owns, which seems to be something the company has done quite well over the past couple of years.
How much can the company grow? In the three quarters prior to the Lucent acquisition in 1998, Bel Fuse achieved sales growth of 13% and earnings growth of 72%. While it is improbable that that the company's earnings will grow that much faster than sales growth in the future (gross margins expanded a mind-boggling four percentage points from 30% to 34% during that period), the company seems well positioned to enjoy the fruits of its growing markets.
Even with sales growth of 10%-15% (which are conservative estimates), the company would appear attractively priced at a P/E of 14, particularly considering that the company still has opportunities for cost improvements to keep earnings growing faster than sales. Just last quarter, Bel Fuse moved manufacturing operations for the Lucent businesses to China, which should lower expenses and improve margins.
One noteworthy feature of Bel Fuse is its low tax rate. For the first nine months of the year, the company's effective tax rate was only 14%, well below the 35%-40% recorded by most American companies. If this rate were unsustainable, investors should figure out what the company would earn at a more normal tax rate (lowering net earnings). With substantial operations and new investments in lower-tax jurisdictions, however, Bel Fuse has been able to keep its tax rate in the 11%-20% range for at least the past six years. Barring changes to these attributes, the low tax rate seems sustainable.
Bel Fuse has two classes of stock, which can be confusing to some people. Class A shares <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BELFA)") else Response.Write("(Nasdaq: BELFA)") end if %> represent voting stock, whereas Class B shares <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BELFB)") else Response.Write("(Nasdaq: BELFB)") end if %> are nonvoting. The only other difference between the two classes is that shareholders of Class B stock receive a quarterly dividend ($0.05/share) that is not paid to Class A shareholders. Since this dual-class stock structure was adopted last year, the Class A shares have generally traded for $1 to $3 more than the Class B shares. While others might argue that they want voting shares, I would be more inclined to pick up Class B shares that carry a lower valuation and also a small dividend.
If you're interested in finding a company that is successfully participating in the booming technology sector but you don't want to pay for an obscene valuation, you may want to see if Bel Fuse is the right connection for your portfolio.