Streetwise for Sunday Nov. 8, 2009

Streetwise

Lauren Rudd

Sunday, November 8, 2009

There Is No Room For Second Place

Vince Lombardi once said, “There is no room for second place. There is only one place in my game, and that's first place. ...There is a second place bowl game, but it is a game for losers played by losers.”

Were those harsh words? No, I do not think so. Rather they are quite pertinent to what your investment strategy should be. A successful investment program requires that you select only the best investment candidates. By paying judicious attention to profitability and intrinsic value you can easily separate the wheat from the chaff.

Keep in mind that I am directing my comments at investing and not trading, a polite word for speculation. A speculator is about as much an investor as a Las Vegas gambler. That statement is not intended to be derisive. Whenever there is a profit to be made by successfully picking the correct outcome of a random event there will be those wanting to bet on the outcome, regardless of risk.

And as in every game of chance there will be winners and losers, with the latter occurring far more frequently than the former. Yet, to their credit, speculators on Wall Street serve a key role in that they provide liquidity to the markets.

An investor eliminates much of the random element through diligent research and the utilization of a time horizon that is measured in years rather than hours or minutes. This time factor not only alleviates minor share price fluctuations, but enables you to benefit from a continual compounding of profits.

Consider for example Toro (TTC), a company whose share price has increased year-to-date by over 16 percent. If you are not familiar with the name, you have never had the pleasure of shopping for a lawn mower.

For its third quarter ended July 31, Toro reported net earnings of $0.54 per share on net sales of $349.9 million, as compared to $0.99 per share and $492 million in sales for the same period a year ago. The company’s gross margin declined to 33.9 percent from 35.3 percent a year ago.

Yes, the recession has taken a toll on the company. However, my 12-month target price on the shares a year ago was $35 and they recently closed at $38.52. Furthermore, the company’s accounts receivable declined by 26.1 percent and net inventories fell by 24.2 percent. Toro’s solid cash flow has meant continued dividend payments and the repurchase of 1.6 million shares, with recent authorization to repurchase another 5 million shares.

The company’s guidance is that fiscal 2009 revenues will decrease by about 18 percent when compared with 2008, resulting in earnings for the year of between $1.53 and $1.63 per share. Included in that estimate is a one-time charge of $0.15 for reorganization expenses.

Despite an operational performance that is considerably less than it was a year ago, the company’s share price is on a steady upward trend since hitting a nadir of $20 last March. A key reason is that the economy is recovering. Furthermore, grass knows no master. It continues to grow regardless of economic conditions, while the need for irrigation continues worldwide and snow continues to fall. Toro has solutions for all the above.

The intrinsic value of the shares using a discounted earnings model is $90, while the more conservative free cash flow to the firm model produces an intrinsic value of $95. My 2009 earnings estimate is $1.67 per share and $2.05 for 2010. My 12-month price target on the shares is $44 for a potential annual capital gain of 15 percent. There is also dividend yield of 1.60 percent, raising that number to 16.6 percent.