By Guest Columnist Chris Fernandez of PeakStocks.com
It’s time to put some money to work.
I don’t profess to know when the markets will turn, or how long it will take, but I do know that there are quality companies out there begging to be purchased, if only in small increments at the present, and held on to for years to come.
The three companies that I have added to my portfolio are probably no secret to anyone who has been following my recommendations for some time: Rick's Cabaret (RICK), eHealth (EHTH) and Pros Holdings (PRO). I am advocating purchasing a quarter position in each one.
We have been given a fantastic opportunity, provided we are a long-term investors and can stomach further drops. I don’t know when the market or these stocks will rebound, and it could very well be that we get to purchase even more shares of these great companies as they come down even further.
The best time to add stocks to your portfolio is when others are panicking and there is blood in the streets. Don’t shy away from great opportunities because of uncertainty.
Below are brief explanations about what the companies do, my reasons for adding them to the portfolio, and some of the risk factors you should be aware of before purchasing shares.
Rick's Cabaret International: 1/4 position at around $7 per share
As of Sept. 30, Rick’s Cabaret owns and operates 19 upscale adult nightclubs, serving primarily businessmen and professionals. It also owns and operates adult entertainment Web sites. In business since 1983, Rick's specializes in providing a safe and upscale environment for adult entertainment.
The adult entertainment industry is fraught with substandard mom-and-pop clubs with low-scale business models. Rick’s differentiates itself by offering an atmosphere that appeals to upscale clientele
Why I bought Rick's:
* Best-in-breed player that is significantly increasing its market share in a largely fragmented industry via intelligent acquisitions.
* Will grow revenue 90% this year and 60% next year and is growing about 10% organically.
* Super high gross, operating and net margins.
* Strong cash flow and free cash flow generation
* High insider ownership (CEO owns about 13% of the outstanding shares).
* Unbelievably cheap valuation using any metric. Discounted Cash Flow, P/E, PEG, P/CF, P/FCF and so on. Rick’s is trading below book value of $7.22 per share!
* Approved share buyback in the amount of $5 million, or about 8% of the outstanding shares.
* Largely underfollowed stock.
* Great way to diversify your portfolio away from more-traditional stocks and consumer discretionary plays.
Potential risks:
* Declining economy could adversely affect operating results, although even if you ratchet down growth to half of what analysts project for next year, you are still getting a dirt cheap stock.
* Stigma of owning a “sin stock” could put a natural buffer on price appreciation.
* Results of operations at some locations in Texas were adversely affected by Hurricane Ike.
* Potential changes in local, state or federal regulations.
* Sensitive market for discretionary income, could fluctuate with declining economy.
* Overall Risk Rating: 7.5 (Moderately High)
Bottom Line: I have been watching and researching Rick’s for quite some time, and given the current valuation of the stock and the fact that it's trading below book value, coupled with a fully vested ownership and the share repurchase program, I felt it prudent to buy a quarter position right now.
I’ll be digging into the Rick’s story further, but as of right now, with all the preliminary research I’ve done, this looks like a sound investment for the long term, even if business declines as a result of the slower economy.
eHealth: Buy 1/4 position around $12.25 per share
eHealth offers Internet-based insurance agency services to individuals, families and small businesses primarily in the U.S. The company’s e-commerce platform, accessed directly via eHealth.com and eHealthInsurance.com, enables individuals and families to research, analyze, compare and purchase health insurance products online. Because of the fixed-cost nature of health insurance, eHealth is one of the only ways that most individuals are able to see what health insurance offerings are available from 175 different companies.
For anyone that is self-employed, runs a small business or, as more and more companies stop paying for employee health insurance, needs to purchase his or her own health insurance, it is becoming increasingly crucial that individuals find affordable health insurance, and eHealth gives them the power of choice.
eHealth has barely scraped its potential in this market, and I have been watching the company since its IPO late last year as its valuation has become much more reasonable.
Why I bought eHealth:
* No other competition on the Internet.
* Offers a wide variety of health insurance plans for any need in one convenient location.
* Is changing the way people shop for health insurance.
* Cheap valuation, especially in light of cash flow metrics.
* Founder/CEO with about 5% of the company.
* High-margin business with recurring revenues and super high cash flow (currently $136 million in cash with no debt, about $5.43 per share).
* Growth potential that far exceeds the market given conservative estimates for next year.
Potential risks:
* Declining economy might force people to forgo health insurance, regardless of the cost.
* Possible changes in legislation (such as universal health care) could affect cost structure of eHealth’s offerings as well as the need for health insurance.
* Increasing customer acquisition costs could signal a peak in the business model.
* Failure of eHealth to become a de facto place to purchase and research health insurance products.
* Slowing growth as a result of these and other factors has cut eHealth’s valuation multiple. If growth continues to slow, or if eHealth has to spend more for customer acquisitions, so too will eHealth’s valuation.
* Overall Risk Rating: 7.5 (Moderately High)
Bottom Line: While risky and not immune to what is going on around us, I believe that eHealth represents a well-managed and seasoned company that has the ability to leverage its business model for future expansion and growth that it has yet to tap into.
With innovative offerings -- such as the ability for underwriters to approve an application as soon as the customer submits it, thus allowing them to become insured immediately -- I believe that once and even before things do turn around, eHealth is in a great position to capitalize on the growing demand for health insurance for those that traditionally could not afford it.
Coupled with the strong financials, cash flow generation and dirt cheap valuation, even when slowing consumer demand is taken into account, eHealth represents another diverse way to play the consumer market.
Pros Holdings: Buy 1/4 position at around $7.00 per share
Pros Holdings is a small business that provides pricing and revenue optimization software worldwide in five major markets: airline, hotel, cruise, manufacturing and services. Pros has proprietary pricing algorithms and systems that have been developed and refined over many years of implementation and experience, providing the company with a distinct competitive advantage over the many rivals that troll the pricing optimization space.
Pros’ customers, which include FedEx (FDX), Hertz (HTZ) and Southwest Airlines (LUV), renew their contracts with Pros at a rate of about 90%.
Especially in today’s environment, finding optimal pricing strategies is paramount to staying ahead of the competition and eking out the largest amount of profit possible.
Why I bought Pros Holdings:
* Reasonable/cheap valuation.
* High insider ownership. Insiders as a whole own more than 40% of Pros’ shares outstanding. Within this group, the CEO owns about 6.8% and the CFO 2.3%.
* High and increasing margins.
* Huge stockpile of cash ($48 million, $0 debt).
* Company approved up to a $15 million share buyback, which would represent about 8% of the total shares outstanding.
* Niche product, high barriers to entry to specific proprietary pricing algorithms, structures and methodologies.
* Continued execution by management: 9 straight years of being cash-flow-positive.
* Steady growth within the industry as well as potential takeover candidate by a larger company.
Potential risks:
* Because Pros’ offerings require a significant commitment by its customers in hardware, software and manpower, shrinking budgets might curtail future orders, regardless of the promise of Pros’ offerings to actually increase company’s profits via its software.
* Increasing competition by new entrants as well as old stalwarts such as Oracle (ORCL) and SAP (SAP).
* Continued deceleration of future bookings and overall slowdown in the marketplace for Pros’ products. In fact, management slightly lowered last quarter’s bookings guidance, a future revenue predictor.
* Overall Risk Rating: 8 (High)
Bottom Line: Pros is trading well below its IPO level of $11 per share, and for good reason. The potential IT slowdown in the tech sector, as well as all the other industries in which Pros operates, leads to a very real possibility that its future bookings will also slow.
That being said, I think that with the valuation coming down to these levels and the strong cash flow business that Pros has, coupled with its share buyback, this is a good time to start a position and wait till Pros reports third-quarter earnings in a couple of weeks.
With its niche product protected by its team of scientists and years of tweaking and experience, Pros is definitely the leader in price optimization software. Once Pros installs one of its systems in a company's computer infrastructure, that company is likely to remain a Pros client for some time. In a time when companies will need to squeeze every last drop of potential profit from their sales, I believe that this company will continue to grow sales and continue to produce large amounts of profit and cash flow going forward, even if sales stagnate.
Posted on Oct. 9, 2008
Chris Fernandez is the founder and CEO of PeakStocks.com, a Web site
dedicated to the micro-cap and small-cap stock universe
A version of this article was originally published here.
