KeyStone’s Your Stock Our Take: Decisive Dividend Corp. (DE:TSX-V) and Quarterhill Inc. (QTRH:TSX), and Dog: Facebook (FB:NASDAQ).
This week in KeyStone’s Stock Talk Podcast, we continue our discussion of the stock market’s coming potential “lost decade”. We take a look at this concept in reference to the Schiller PE and if the Market is Cheap or Expensive at present.
In our Your Stock, Our Take segment we take a look at a couple of small-cap companies sent in by listeners, including a dividend payer and one cash rich technology play.
The first, Decisive Dividend Corporation (DE:TSX-V), is an acquirer of diverse profitable companies including everything from a wood and gas stove business to and air blast sprayers and a business that provides products to the cement, mining, oil and gas, aggregate, and coal industries.
The second is, Quarterhill Inc. (QTRH:TSX), historically an IP licensing business which is now focusing on the acquisition and management of technology companies that provides products and services worldwide.
Finally, our Dog of the week, FaceBook (FB:NASDAQ), which needs no introduction. Mark Zuckerberg’s social media giant has come through the pandemic well, but is facing significant challenges near-term – Aaron discusses the impact on the stock.
Potential “Lost Decade”
This week, we discuss the Schiller PE and if the Market are Cheap or Expensive?
Last week we discussed the Headline provided from Bridgewater founder Ray Dalio that “The stock market could be on the verge of a ‘lost decade,’. Bridgewater, is the largest hedge fund manager in the world – so people tend to listen.
The premise was based on the idea that Globalization, which has driven profitability over the past few decades, has already peaked and that cost optimization has taking a back seat to a focus on reliability and the duplication supply chains given the issues from the pandemic.
In theory, this leads to lower margins and less profitability. Perhaps this will be part of the equation. But, if I was to make this argument, for a lost decade, I would make it on the basis of broader valuations.
To do this we look at a CAPE, not Batman or even Superman’s – I am referring to a cyclically-adjusted price-to-earnings (CAPE) ratio of a stock market is one of the standard metrics used to evaluate whether a market is overvalued, undervalued, or fairly-valued.
This metric was developed by Robert Shiller and popularized during the Dotcom Bubble when he argued (correctly) that equities were highly overvalued. For that reason, it’s also casually referred to as the “Shiller PE”, meaning the Shiller variant of the typical price-to-earnings (P/E) ratio of stock.
Why the CAPE Ratio is Important?
Robert Shiller demonstrated using 130 years of back-tested data that the returns of the S&P 500 over the next 20 years are strongly inversely correlated with the CAPE ratio at any given time.
In other words, whenever the CAPE ratio of the market is high, it means stocks are overvalued, and returns over the next 20 years will likely be poor or at least less than the returns experienced over the previous period. In contrast, whenever the ratio is low, it means the stocks are undervalued, and returns over the next 20 years will likely be good.
This is intuitive. When stocks are cheap, they can increase in price both from increasing corporate earnings and from an increasing price-to-earnings ratio on that figure. But when stocks are already expensive, and already have a high price-to-earnings ratio, they have a lot less room to grow and a lot more room to fall the next time there’s a recession or market correction.
Where are we now?
Shiller PE: 28.5 (+ 1.206%)
Shiller PE is 10.1% higher than the recent 20-year average of 25.8
Implied future annual return: 4%
Recent 20-year low: 13.32
Recent 20-year high: 42.87
S&P 500: 3045.35
Regular PE: 26.2 (Recent 20-year average: 25.5)
Does not sound too expensive based on the past 20-years – but based on the past 100-years plus, it is a bit more expensive.
If we look at the Schiller PE – it may be in agreement with this sentiment. However, it is a market of stocks, not a stock market.
There are still great healthcare, infrastructure and tech companies we want to own regardless of market conditions.
A lost decade for stocks makes for great headlines but is a lost concept for me.
Your Stock Our Take
Naveed via Youtube – “I’ve been in decisive dividend on tsxv for over 2 years. It was hovering around $4 during that time until recently going down to $3.00 I’m down 25% and would love to know what you think about this company.”
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Decisive Dividend Corp. (DE:TSX-V)
Current Price: $1.55
Market Cap: $16.7 Million
(TTM) Yield: 23%
What does the company do?
Decisive Dividend Corp. was established to acquire a growing stable of successful manufacturing companies for the long term that provide steady and growing dividend payments to its shareholders. To date, the company has completed the acquisition of five manufacturing companies.
These subsidiaries include:
- Blaze King – Sells wood burning stoves & gas stoves.
- Slimline – Air blast Sprayers
- Unicast – Distributing wear parts and Valves for mining
- Hawk – Customized machining shop
- Northside – Welding & Fabrication
Key Points:
Looking at the company’s past share price performance, since 2017 the stock has range traded between $3.50-4.50, recently taking a hard hit after the outbreak of COVID-19. Which led the company to suspend its monthly dividend on March 31, 2020 and caused the share-price to collapse to a 5-year low.
Recent Financial Results: (Q1, 2020)
- Revenue was up 31%, to $12.95 million compared to the same quarter last year.
- Adjusted EBITDA was up 112% to $1.65 million compared to $778 thousand for the same period last year.
- Net Loss Per Share (EPS) came in at a loss of $0.09 compared to a loss of $0.02 for Q3, 2019.
Our Take:
In the near term, because of the drop-in oil prices and the outbreak of COVID-19, management expects that each of its subsidiaries will continue to experience some level of negative effect on their supply chains and customer demand (operating in manufacturing). So, with this being said we do remain cautious on the business at this time.
I believe that it was prudent for Decisive to momentarily suspend its dividend while the company deals with headwinds. Plus considering the company holds a lot of debt on its balance sheet with a Net Debt-to-Adj. EBITDA multiple of ~3.6 times and a D/E ratio of over 1.
We would expect more debt on the company’s balance sheet seeing as the company’s subsidiaries are in relatively capital-intensive manufacturing businesses. But these multiples are getting to the upper end of where we would like to see them. And it leaves us a little concerned with the question marks around the impact of oil prices and COVID-19 on future operations.
Decisive has been able to grow its top-line revenue through acquisition decently and on a valuation basis they are trading at relatively low multiples, coming in with an EV/Adj. EBITDA multiple of around ~6. This in my opinion places Decisive currently trading around fair value, as the business is expecting operational headwinds, it recently cut its dividend and carries a large amount of debt on its balance sheet.
To conclude, due to the uncertainty regarding the company’s future operations and dividend – it is not a stock that we would recommend at this time.
Weekly Dog
Facebook (FB: NASDAQ)
Current Price: $215
Market Cap: $615 billion
What does the company do?
Facebook is the world’s largest online social network, with 2.5 billion monthly active users. The company’s social media platforms consist mainly of the Facebook app, Instagram, Messenger, WhatsApp, as well as additional features and products. Advertising sales represent more than 90% of the company’s total revenue.
Key Points:
Facebook shares have dropped about 10% over the last week after hitting an all time high of $242 on June 23rd.
Recently, the company has been the focus of a campaign called #StopHateForProfit, whereby advertisers have been pulling their ad budgets from the social media giant in response to Facebooks inability to control racist and violent content on its platform. Major advertisers how have suspended programs with Facebook include Coca-Cola, Diageo, Unilever Starbucks.
We monitor Facebook very closely in our U.S. Growth Stock research. It’s a profitable, cash-rich company that passes several of our criterion. However, in spite of relatively strong financial results in Q1 of this year, we did note that management started to see a meaningful drop in ad revenue towards the end of the quarter due to the pandemic and shelter-in-place orders. This was before the company recently came under fire for its content.
Recent Financials:
- Q1 2020 revenue was $17.7 billion, an increase of 18% year-over-year.
- Net income per share was $1.71, an increase of 101%.
- Facebook daily active users (DAUs) were 1.73 billion on average for March 2020, an increase of 11% year-over-year.
- The company has a cash balance of $60.3 billion and total debt of $10.3 billion, equating to a net cash balance of $17.43 per share.
- The company has reported adjusted EPS of $7.29 per share over the past 12 months which puts the trailing price-to-earnings valuation at ~30 times.
- Engagement increased due to the shelter-in-place orders but demand for advertising and pricing dropped significantly during the last 3 weeks of Q1.
- The company has seen some stabilization at the start of April and but is not providing financial guidance for Q2.
Conclusion:
FB is a dominant player in the social media space and mobile advertising market. The company produced strong growth in Q1 but noted that advertising revenue began to drop near the end of the quarter. The company has strong fundamentals, but our concern is that the stock price is only slightly off its all-time high in spite of a significant amount of uncertainty in the near term.
Your Stock Our Take
Quarterhill Inc. (QTRH:TSX)
Current Price: $2.05
Market Cap: $243 million
What does the company do?
Quarterhill has an interesting history. The company originally created great IP in the wireless arena under the name WiLan. The business then went on to basically become a “patent troll” – defending its own IP, but purchasing other IP and employing a team of lawyers to litigate to enforce payment from larger companies to use the IP. Revenues were lumpy and the market soured on these types of businesses and awarded them generally low multiples.
Today, the company states it’s mission is to “acquire, empower, and grow technology companies.” Quarterhill’s emphasis is on seeking out acquisition opportunities at reasonable valuations that provide a foundation for recurring revenues, predictable cash flows and margins, profitable growth, intimate customer relationships and dedicated management teams. Sounds great, but the businesses acquired to date, have not provided significant, predictable cash flow – and were often not acquired at very reasonable prices to their underlying cash flow.
Most Recent Quarter Q1 2020:
Revenue was $26.0 million, down from $52.96 million Q1 2019, and only $6.2 million (24%) was recurring revenue.
Adjusted EBITDA was $0.8 million, down significantly.
Net loss was ($5.1) million, or ($0.04) per basic and diluted common share.
Cash generated from operations was $9.1 million – but limited recurring revenues, so low predictability going forward.
Great cash balance: Cash and equivalents were $103.1 million at March 31, 2020.
Jury awarded US$85.2 million in damages to WiLAN in its patent suit re-trial against Apple.
Appointed Paul Hill as President and Chief Executive Officer of Quarterhill, effective June 1st.
Announced on May 19th that it had completed the sale of its total investment in VIZIYA, which represents its Enterprise Software segment, for total cash proceeds of $49.4 million. This was a company that was acquired in 2017 for $40.5 million to create meaningful recurring cash flow…now it has been sold.
Our Take
Quarterhill has a great balance sheet with roughly $103 million in cash which will be substantially added to via the sale of VIZIYA and potentially the lawsuit win against Apple (but we would not advise holding our breathe for that payment).
On a trailing basis, valuations look fairly attractive, but this is factoring in some one-time payment wins from the past year. The company’s core recurring revenues remain small and the business is not profitable with these core revenues alone.
Quarterhill is a bet on the new management teams’ ability to affectively on deploy capital on hand on a go-forward basis. While intriguing, the company will be all about execution and with a limited track-record and no existing recurring profitability, Quarterhill remains outside our criteria for investment. We monitor it.
