More than two decades ago, I was just getting my start in the financial industry, working as a licensed representative for a major mutual fund company. In order to help new hires like me get more familiar with what mutual funds were about, and to start learning how the stock market worked, my employer encouraged studying the investment philosophies of a lot of the most well-known fund managers of the day. At the time, that meant paying attention to the “rock stars” of the mutual fund industry, and at that time there weren’t too many more popular or well-known names than Peter Lynch.
Peter Lynch made his name, and his personal fortune, managing Fidelity Investment’s flagship mutual fund, the Magellan Fund, in the 1980’s. His investing success – he averaged a 29.2% annual return from 1977 to 1990 – helped make Magellan the biggest mutual fund in the world at the time, as it grew from $18 million in assets under management to more than $14 billion during his tenure. In the process he helped to put Fidelity at the top of the heap of the mutual fund industry. After he retired from fund management, he wrote about his investing approach in books like One Up on Wall Street and Beating the Street.
One of Mr. Lynch’s best-known investing principles is simple: “invest in what you know.” His logic was as straightforward as it sounds. If there is a product or service that you find yourself making use of on a regular, consistent basis, it would probably be a good idea to take the time to check out the company behind it. You might find that there is a really interesting investing opportunity to be had. It’s an attractive approach, because it makes it easy to slice through a lot of market noise about what’s hot right now, or to avoid worrying about what your neighbor next door might be doing in the stock market.
The problem I’ve found over the years is that a lot of investors take the suggestion a little too literally. Hoping to simplify the market, they actually oversimplify the question. They might simply assume, for example that the fact they like to swing through the drive-thru at Starbucks (SBUX) each morning for a hot cup of coffee and a pastry is reason enough by itself to go and buy the stock. They don’t actually take the time to follow Mr. Lynch’s suggestion all the way through the way he meant it, which is actually to use products you know and love as just a starting point in deciding what areas of the market you want to pay focus on. Whether or not SBUX would actually be an investment worthy or your hard-earned and carefully-saved investing capital requires more thorough analysis and planning.
Personally, I’ve found the “invest in what you know” idea as a great way to get started. When I’m scanning the market for new opportunities and potential investments, I naturally gravitate to names I recognize. And there is nothing wrong with that – as long as I make sure that every stock I consider goes through the rest of my analysis process, which includes a thorough check of the company’s fundamental profile and real value proposition right now. That’s what leads me to Tootsie Roll Industries (TR), the stock in my headline for today’s post. Every American kid knows the name, as well as practically every kind of candy or gum the company makes. The interesting thing about this small-cap stock, however is how strong their fundamentals are, and how attractive the stock’s long-term opportunity could be. It might even be good enough to pass muster for Mr. Lynch.
Fundamental and Value Profile
Tootsie Roll Industries, Inc. and its subsidiaries are engaged in the manufacture and sale of confectionery products. The Company offers a range of candy, chocolate and bubble gum brands. Its products are marketed in a range of packages deTRned to be suitable for display and sale in different types of retail outlets. The Company sells its products under the brand names TOOTSIE ROLL, TOOTSIE POPS, CHILD’S PLAY, CARAMEL APPLE POPS, CHARMS, BLOW-POP, CHARMS MINI POPS, CELLA’S, DOTS, JUNIOR MINTS, CHARLESTON CHEW, SUGAR DADDY, SUGAR BABIES, ANDES, FLUFFY STUFF, DUBBLE BUBBLE, RAZZLES, CRY BABY, NIK-L-NIP and TUTSI POP (Mexico). As of December 31, 2016, its products were sold through approximately 30 candy and grocery brokers and by the Company itself to customers throughout the United States. Its customers include wholesale distributors of candy and groceries, supermarkets, variety stores, dollar stores, chain grocers, drug chains, discount chains and cooperative grocery associations. TR’s current market cap is $1.1 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings decreased a little over 13%, while sales growth saw a negligible increase of about .7%. The picture has gotten much better in the last quarter, where earnings increased more than 23%, while sales increased 4.7%. The stock operates with a pretty healthy margin profile; over the last twelve months, Net Income was nearly 15% of Revenues, and while it narrowed in the last quarter, it remains solid at nearly 10%.
- Free Cash Flow: TR’s free cash flow isn’t incredibly impressive, since it translates to a Free Cash Flow Yield of a little less than 2% of the stock’s market cap; however when you consider that the stock’s balance sheet has carried no long-term debt since June of last year, this becomes a much smaller concern.
- Debt to Equity: TR has a debt/equity ratio of 0 as already observed, against a little over $108 million in cash and equivalent assets. That means that the company is operating with good liquidity and carries very little financial risk since it doesn’t need to worry about its debt service.
- Dividend: TR pays an annual dividend of $.36 per share, which translates to a yield of 1.26% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for TR is $11.30 per share and translates to a Price/Book ratio of 2.51 at the stock’s current price. Their historical Price/Book average is 3.07, which suggests that the stock is trading at a discount right now of about 22%. Their Price/Cash Flow ratio offers a supporting perspective, since it is currently running about 27% below its historical average. Between the two measurements, the long-term target price, based strictly off of value analysis could lie in the $35 to $36 range. It is also worth noting here that the stock’s Book Value has increased steadily since the beginning of 2014, which it was actually $0.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The chart above traces the stock’s downward trend from over the last two years to its low in May of this year at around $27.50. After staging a short-term rally to about $32 per share in early July, the stock dropped back near to its trend lows, but is showing solid signs of stabilization over the last six weeks between $28 and $29 per share. That is a narrow range that is creating a sideways short-term trend, and flattening both the intermediate and long-term trends. A break above that range to around $30.50 could be a good indication the stock is building a new base for a bullish trend reversal, and could see the stock push back into the mid-$30 range where our value-oriented analysis lies.
- Near-term Keys: If you like the stock’s value proposition right now, and are willing to tolerate the potential that the stock could break below its current support level, there is plenty of reason to think about buying the stock with a long-term target price around $35 per share, or perhaps higher. If you prefer to work with a shorter time frame with call or put options, look for a break above the $29 range for a short-term swing opportunity with call options, with an immediate target between $31 and $33 per share. A break below support to around $28 could be a good signal to work with put options, with a target price in that case around $26 based on previous pivot levels the stock last used in 2014.