Recently, the Harvard Business Review reported a study from 1992-2006 on differences in industry profitability. The average return on invested capital varied markedly from industry to industry. At the high end are industries like soft drinks and prepackaged software which have been almost six times more profitable than the airline industry over the period.
Security Brokers and Dealers: 40.9%
Soft Drinks: 37.6%
Prepackaged Software: 37.6%
Pharmaceuticals: 31.7%
Perfume, Cosmetics, Toiletries: 28.6%
Advertising Agencies: 27.3%
Distilled Spirits: 26.4%
Semiconductors: 21.3%
Medical Instruments: 21.0%
Men’s and Boy’s Clothing: 19.5%
Tires: 19.5%
Household Applicances: 19.2%
Malt Beverages: 19.0%
Child Day Care Services: 17.6%
Houshold Furniture: 17.0%
Drug Stores: 16.5%
Grocery Stores: 16.0%
Iron and Steel Foundries: 15.6%
Cookies & Crackers: 15.4%
Mobile Homes: 15.0%
Wine and Brandy: 13.9%
Bakery Products: 13.8%
Engines and Turbines: 13.7%
Book Publishing: 13.4%
Laboratory Equipment: 13.4%
Oil & Gas Machinery: 12.6%
Soft Drink Bottling: 11.7%
Knitting Mills: 10.5%
Hotels: 10.4%
Catalog, Mail-Order Houses: 5.9%
Airlines: 5.9%
The average industry Return on Invested Capital in the U.S. was calculated to be 14.9%.
The industry topping the list, Security Brokers and Dealers, prompted me to investigate the fundamentals of some online brokers. Among them, OptionsXpress popped out as a compelling value proposition.
Scanning valuation metrics, I noted that OptionsXpress had a Market Capitalization of 1.59Bn but an Enterprise Value of just $918M. Relatively, that is a huge difference; so huge in fact that it caused me to look immediately to the Balance Sheet to confirm the cause of the disparity. On the Balance Sheet was listed a whopping $669M in cash and zero debt. (Cash, Debt and Market Capitalization are all factored into Enterprise Value).
The Income Statement was the next area of interest. Revenues reported were $247M while Gross Profit was $166M according to Yahoo! Finance. The fact that so much of the top line figure drops lower on the Statement indicates high margins and this is precisely the case. Indeed, the Profit Margin is 39.56% and the Operating Margin is 64.59%. These margins are not especially surprising given the margins reported in the study are so high.
One of the most important areas to focus on when evaluating financial statements is the Cash Flow statement. According to Google Finance, the all-important Net Change in Cash is $66M which is very attractive given that the revenue figures are only about four times that number. Digging deeper into the Cash figures, we can see Cash from Operating is $107M, Cash from Investing -$29.75M is and Cash from Financing is -$10.91M. The bottom line is OptionsXpress can add substantially to its cash hoard each and every year.
Although some insider selling did take place when the stock was in the $30s, it appears executives realize that shares are undervalued. Recently the board of directors approved a plan to repurchase up to $100M in outstanding common stock.
On November 1, the company had about 63 million outstanding shares so this would enable them buy back approximately 4 million shares. The Board also approved a plan to repurchase up to 200,000 shares each year to offset dilution from employee stock compensation. Repurchases will be based on the 30-day average trading price of the stock before the repurchase.
The company also reported recently that trading volume had increased 40% in January to an average of 41,200 trades per day. Additionally, the company added a further 4,900 accounts during the month, bringing its total to 267,300, 23% higher than in January 2007. Clients assets increased 10% compared with January 2007 to $5.4Bn but fell 6% since December.
Jim Cramer mentioned that he liked the company but could see no catalyst to price appreciation. He may well be right in the short-term and the market volatility may indeed cause the stock to move lower in the short-term. But – and it’s a big but – the share buyback plan means an effective put option exists to shareholders. As a stockholder you know that management will support the stock by stepping in to buy on down days. Moreover, the market volatility already seems to be encouraging traders to hedge more which is a positive for OptionsXpress.
In the past, speculation has run rampant that OptionsXpress was a takeover target. At its current valuation, it is very attractive to prospective buyers and if there ever was a time to make a run at OptionsXpress, this might well be the time for potential acquireres when market sentiment is still poor.
As a long term play it is difficult to envisage a scenario where OptionsXpress does not outperform from current price levels. Each month they add cash to their existing pile and each month the valuation looks more and more understated. The protection through the share repurchase scheme means the risk to the downside is reduced and so the risk/reward ratio is especially compelling over the long-term. In the short-term substantial risk to the market over the next 2-3 months and bearish sentiment could certainly impact stock price.
Have a Fantastic Week!
OptionSage
