XP has the Power

Growth at a reasonable price I am now going to use the ‘G’ word. ‘G’, is for profit growth, which is not something I spend a lot of time speculating about. But the appearance of a growing company, XP Power (XPP), in the Thrifty 30 shortlist, which identifies financially strong companies at cheap prices, or value shares, thrusts us into the heady world of growth investing. XPP has also popped up in John Mulligan’s STAR screen, a mechanical trading system I have long admired, that identifies growth companies at cheap prices. Does XP Power, which designs and manufactures power adapters for the technology, industrial and healthcare markets, promise growth, and value? Many foolish words have been penned on growth, often assuming that past growth rates will continue indefinitely into the future. I prefer the opposite assumption, as a general rule, that rapid growth is ephemeral, and that if a company achieves a high price because of its growth prospects, investors will probably be disappointed. Using an average PE ratio is therefore a conservative measure. In comparison to the most recent PE ratio, or forecasts, it penalises growth companies because their lower past earnings reduce the earnings denominator and make the price look higher in comparison. It takes a particularly lugubrious investor to insist that a company that has grown markedly over the last five to ten years sell for a bargain price. Less, say than ten times average earnings. XP Power doesn’t, but depending on how many years you average its earnings over, it gets quite close. Averaging its six year earnings record (back to 2004), produces a PE of 13, while averaging its nine-year earnings record back to 2001 (as much data as I have), produces a higher PE of 17. Usually I would prefer the longer average, but between 2002 and 2005 XP Power was transforming itself from a distributor of third-party power adapters into a designer and manufacturer. Since then it’s done all the right things: grown profits relatively steadily, and paid off debt. It’s quite possible that the lower profits it earned in those years are unlikely to recur, especially as profits have grown through this recession: But will it continue growing? There are many reasons to believe it will. XP Power has moved to Singapore, closer to its Chinese factories. Its market share in Asia, its new home market, is very low compared to Europe and America. By moving into manufacturing at a time when rivals were increasingly outsourcing production, it has more control over quality and costs, and can focus on making smaller, more efficient, adapters. And it sells to over 6,000 customers around the world, in three sectors, so it’s unlikely to suffer too badly if one customer, or even one industry falters. Short of a full-blown analysis of XP Power’s strategy, return on capital is probably the best way to assess its growth prospects. If it’s highly profitable, it will have plenty of money to invest, and plenty of opportunities to invest in, increasing the company’s profits, and value to investors in the future, and making it worth paying more for now. If it’s to turn that potential into increased profit, I reckon it ought to show up in good return on capital now. Even if we use the most conservative measure, return on total assets, XPP consistently achieves a return of about 13% (the dip in 2007 was due to the costs of its move to Singapore and the cost of terminating some of its third party lines). That supports a prediction of steady, if unspectacular growth, and I think means XPP shares could be cheap at a price of 13 times average earnings. The shares have been much cheaper though. It seems remarkable that investors could have valued them at less than 150p a share a year ago. The directors of the company, who between them have a controlling interest of 34%, have taken the opportunity to lift their stakes since then. They’re still buying. In February, ceo Duncan Penny bought 20,000 shares at 435p a share, and I’m going to join him by adding XP Power to the Thrifty 30 portfolio at 432.67p, the actual price quoted by my broker. [correction: the 6 year average PE of XP Power is 13, and not 12 as I initially reported] - I’m not making this up Value Investor buys Luminar, one of the cheapest six stocks in February. Michael ‘The Big Short’ Burry is rapidly becoming the new contrarian’s hero. Street Capitalist surmises his early bulletin board posts. They don't make charts like this anymore: Booms & Recessions since 1775 (Full chart [PDF]). Aswath Damodaran is preparing to explain all those accounting nasties, goodwill, exceptional items, that befuddle investors and analysts so. John Cassidy writes an indifferent review of a positive book about our (well, the US') economic past and future. I’m not making this up. Jeff Matthews is tweeting. I’m not making this up either: I’m one of Times Money’s favourite twenty five personal finance tweeters.