Investment Jungle

My new Rule #1 screen delivered a list of 31 potential wonderful businesses selling at attractive prices. And at the top of my list, with an earnings yield of 15.08, was Encore Wire Company (WIRE). And of course, Investment Jungle reader Tri had recommended that I have a look at this stock.

Company Profile:

From the 10K Annual Filing:

Encore is a low-cost manufacturer of copper electrical building wire and cable. The Company is a significant supplier of both residential wire for interior electrical wiring in homes, apartments and manufactured housing, and commercial wire for electrical distribution in commercial and industrial buildings.

The principal customers for Encore’s wire are wholesale electrical distributors, which serve both the residential and commercial wire markets. The Company sells its products primarily through manufacturers’ representatives located throughout the United States and, to a lesser extent, through its own direct in-house marketing efforts.

Encore’s strategy is to further expand its share of the markets for building wire primarily by emphasizing a high level of customer service and low-cost production and the addition of new products that complement its current product line. The Company maintains product inventory levels sufficient to meet anticipated customer demand and believes that the speed and completeness with which it fills customer orders are key competitive advantages critical to marketing its products. Encore’s low-cost production capability features an efficient plant design incorporating highly automated manufacturing equipment, an integrated production process and an incentivized work force.

WIRE is a small cap with a market capitalization of $688M.

Financial Analysis:

Looking at the Rule #1 Big Five numbers, I see some interesting results.

The Return on Invested Capital (ROIC) shows how well management is able to redeploy surplus cash within the business. Looking at the 10 year history of WIRE, I see an ROIC that has jumped around a lot. Back in 1997 and 1998, the ROIC was 23.50% and 13.80% respectively. This meets the Rule #1 minimum of 10%. However, the next five years definitely do not. ROIC was in the single digits. In the last 3 years, management has sprung back to life and delivered ROIC of 15.90%, 17.80% and 27.00% respectively.

This definitely requires more investigation. Has it been the same management team for the whole 10 years? Was a new management team put in place in the last 3 years? Assuming that this stock is a wonderful business, these will be questions that will need to be answered.

The Equity growth rate shows similar behaviour. There is a 4 year span of single digit growth rates followed by exceptional growth of 14.26%, 28.66%, 31.54% and 54.73%. Something definitely changed over these last 4 years.

Sales growth rate also shows 4 years of either negative growth or very low growth. However, the last 4 years has been stupendous.

And with all this success over the last 4 years, cash flow growth rate has also been stellar in the last 4 years.

Although the 10 year and 5 year numbers are over 10%, those 3 to 4 leans years in the middle do worry me.

Stock Analysis:

In order to come up with the sticker price, I have to determine an EPS growth rate to use in my calculation. The 10 year average is 19.92% and the 5 year average is 26.72%. I usually take the more conservative approach and will use the lower of the numbers. In this case, 19.92% would be my number and being conservative, I rounded down to 19%.

Unfortunately, I only found 1 analyst that was following this stock, and I was not able to find an estimate. Not that the estimate of a single analyst is all that useful. However, if the analyst predicted a lower EPS growth rate than mine, I would have used the more conservative estimate.

Determining a P/E was easier. Both the 5 year and the 10 year average P/E is hovering right around 15. So 15 is the P/E number that I will use.

Magically combining all these numbers gives me a sticker price of $93.96. And being a value oriented Rule #1 investor, I only want to pay 50 cents on the dollar (just in case I made a mistake somewhere!) and that leaves me a Margin of Safety (MOS) price of $46.98. Wow. At Friday’s closing price of $28.64, that means there is a discount of 69.52% of the sticker price AND in fact, there is also a discount of 39.04% of the MOS price!

Double WOW. This is the first time I have found a company priced below its MOS price!

Conclusion:

Although there is some concern about what occurred over that 4 year span where all the Big Five were in single digits, this company definitely deserves a deeper investigation.

Here is a summary of my findings.

Popularity: 9%