Disclosure: I now own a tiny stake in Automodular. This article is NOT a recommendation that you buy this — or any — particular stock.
The week before last I bought Automodular (Symbol: AM.TO), a stock traded on the TSX. Automodular was the best purchase based on my process of fundamental analysis for value investing (a.k.a. dividend stock investing). Today I’m going to explain why I bought these shares at $1.80 each (by the way, my commission was only $4.95, thanks to Canada’s best discount brokerage, Questrade – sign up now for $50 in free trades!).
When I ran a stock screener search back in August, I noticed AM.TO based on these three criteria:
- The Dividend Yield (DY) was off-the-charts. They pay a quarterly dividend of 6 cents a share. My purchase price means the yield is over 13%.
- Its Price-to-Earnings (P/E) was low, which is awesome. But it’s so low — varying between 2 and 4 over the last year — that I was kind of worried (“too good to be true”, etc.).
- Automodular’s Price-to-Book (P/B) fluctuates around 1. Again, crazy low. Book value almost always involves some intangibles so, in the event of bankruptcy, shareholders won’t get all of the book value back. But given its high ratio of tangible assets, this is an extremely nice cushion.
It also passed my “smell test” for solvency and stability:
- The company keeps more than enough cash on hand to pay its current liabilities (current ratio).
- The Debt-to-Equity ratio is low and its Interest Coverage ratio is great.
- During the Great Recession, this company had some cashflow issues but, from what I can tell, not anymore. It seems management learned from its mistakes and keeps the company more liquid.
- The dividend appears very sustainable. For the quarter ended June 30th, 2012, the payout ratio was under 30%.
As I researched the company, I had two nagging concerns about Automodular:
1. Ford is the company’s bread-and-butter. The Big 3 manufacturer holds a near-monopsony (exclusive buyer relationship) over Automodular. If Ford croaks, reneges, or awards its sub-assembly contract to another company (this contract expires in 2014), then Automodular is toast. If Ford stays with Automodular for another few years, then the latter company will likely remain a milk-able cash cow for small-time investors. This is the gamble that I think is priced into the shares. If my friend Nelson can make a residual equity bet on Research in Motion (which appears to be Canada’s next Nortel), then surely I can bet on the desire of Canada’s auto industry to subcontract work to smaller, more efficient companies.
The company is trying to diversify into other markets, e.g. wind energy. But let’s be honest: AM lives and dies by Ford. I’m rolling the dice, hoping that Automodular will have some nice equipment and plant assets to liquidate if the company breaks up with Ford in two years.
2. The CAW negotiations were looking pretty grim for a short period of time. If the Canadian Auto Workers had gone on strike, Ford probably would have shut down a lot of production, hurting revenue in the short-term. Luckily this didn’t come to pass, but I still waited to hop in until labour peace was assured.
To buy this stock, I disregarded two of my general ‘rules’ of investing:
- Automodular is a penny stock. I avoid stocks trading well under $5. The nominal price shouldn’t truly matter, but I do think “penny stock” status can adversely impact a stock. Clearly I believe in the semi-strong efficient-market hypothesis (EMH); technical analysis is a valid consideration, but is always trumped by fundamental/value analysis.
- AM.TO is a nano-cap stock on a US scale. Even for Canada, a sub-$50 million market cap is small compared to the mean cap of over a billion dollars. You may recall that I prefer the relative liquidity and stability of large cap stocks over micro-cap stocks.
While I don’t think disregarding those two principles was a bad idea, I did make one key mistake in executing my trade.
No, it wasn’t the cost of commission. I used Questrade so I paid next-to-nothing.
I failed to buy AM near the bottom of a recent dip — despite the fact that it dropped well below my target entry price. I’ve been watching Automodular hang around close to two bucks since August. When the price started to fall with strong trading volumes, I chickened out (even though it was ex-dividend so a drop made sense). It hit $1.60 for a brief moment and I should have gladly jumped in (though I bet I would have gotten it for closer to $1.65). But I didn’t buy. The stock promptly regained its footing. I executed my purchase of AM.TO at $1.80 — instead of a 14.5% annual dividend, I stand to earn 13.5%.
Dividends matter, emotions shouldn’t. Live and learn.