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Strategies & Market Trends : Greenblatt's Little Book That Beats The Market -- Ignore unavailable to you. Want to Upgrade?

To: Paul Senior who wrote (155)	4/6/2008 8:05:11 AM
From: bruwin	Read Replies (1) \| Respond to of 218

WOOF .... and Greenblatt. If we look at WOOF’s long term chart we see that its price has risen by 123% in the last 3 years, which is the equivalent of 30.7% compound per annum. That’s good going. So why has its price fallen by over 38% from $45.38 to $28.1 in the last 5 months ? Is it a case of "general Market sentiment", which may have nothing to do with WOOF’s Fundamentals, or is it because of WOOF’s Fundamentals. If it was the former then one could very well be buying a currently undervalued stock. But what if it isn’t ? The attractiveness of this stock was based on a high ROE. Well, maybe it does have a high ROE, but Greenblatt doesn’t use ROE as his criteria. Instead he uses the ratio of EBIT/Capital Employed, which is a fair bit different from ROE. The other criteria quoted was a low earnings yield. Well, "Earnings Yield" is the ratio of Earnings/Price. What Greenblatt uses is EBIT/Enterprise Value. And "Enterprise Value" is what some believe is the theoretical takeover price of a company, or its "Value". IMO the ratio EBIT/Cap.Employed is one of several good criteria by which to judge a company’s current ability to generate shareholder value. Personally, I can’t say the same for EBIT/Enterprise Value. The denominator in that ratio seems similar to the principle of Book value, which tells one very little, if anything, of an industrial type company’s ability to generate shareholder value. It really only comes into its own should the company be liquidated or sold. So back to the question regarding WOOF’s price fall ... A clue may be in the fact that this fall has occurred in the last 5 months or so. So let’s look at its recent Quarterly results. Here we see a fall off in its Turnover, a fall in its EBITDA Margin (although at a current 19.6% it’s still good), and an increase in its Debt Expense. Of those 3 aspects I’d say the most telling one is the effect of Debt on the Income Statement. WOOF currently sits with a Debt/Equity ratio of close to 100% !! That’s high in anyone’s language. Its last quarterly interest expense was $32.9mil., which is 25% up from the previous Quarter. In addition, the Long Term Debt on its Balance Sheet currently sits at $552.3mil. In the previous 3 years that was $384.1m., $446.8m. and $390.8m. respectively. So WOOF has had to increase its borrowing by an average of 36% over the previous 3 years. One has to wonder why the company has seen fit to do that and incur the expense, rather than to use from its Reserves ? Unfortunately Retained Earnings sit at $275mil., so maybe WOOF needs more Capital for its own reasons. Current interest rates are low, so maybe now’s a good time to borrow. But rates don’t stay low forever, and if borrowed money is not put to good use it will continue to cost WOOF. (As an aside, I’ve heard Warren Buffett say that he’s never borrowed money. Must have had his reasons.) Pretax return on Capital may have been good up till now, but does that necessarily mean that business will be good "going forward" ? Something else to consider is the percentage increases in WOOF’s Turnover in the last 5 years. 4 Years ago it went up to 23.8%. It then went to 24.6%. But in the last 2 years it’s fallen back to 17.1% and 17.6% respectively. In the last 3 Quarterlies we’ve seen it fall from 13.3% to 2.1% to the latest -7.3%. IMO one would want to see a reversal in that Turnover trend and a reduction of its debt, because that may be what is needed before we see a reversal in its falling price. If that’s valid, a potential buyer of this stock may want to first see evidence of that in WOOF’s future Quarterlies.