Tom Konrad, CFA
Our recent article on Ruggedcom’s (RUGGF.PK, RMC.TO) technology for a smart grid that’s also robust against a number of threats such as cyberterrorism and electromagnetic pulses prompted a long-time reader to ask if we also think it’s a good investment at these prices.
Good question. As outlined in the article, Ruggedcom, Inc. has a robust business providing ruggedized routers for mission-critical networks, including electric utilities growing smart grids. But not every great business is also a great stock.
What Makes a Great Stock
There are several things I look for in a great stock, and a strong business is only one of them. They are:
- A good business.
- A strong balance sheet and cash flow that can allow the company to continue executing its business model when external financing is scarce.
- Competent and honest management with both an understanding of the business and a record of straightforwardness with shareholders and analysts.
- A good value for the money.
Balance Sheet and Cash Flow
Based on Ruggedcom’s Fiscal 2010 second quarter financial statements, released Nov 4, the company had $63M in current assets (those which can be turned into cash in less than a year) and $13M in current liabilities and negligible long term liabilities on September 30, 2009. Cash from operating activities in the six months to September 30, 2009 was $652 Thousand, down from over $6M the year before.
The large drop in operating cash flow is explained by large increases in sales and research staff, as well as negative exchange rate effects from the appreciating Canadian dollar, while revenues continue to grow despite the markedly difficult economy in Q2 and Q3 2009 when compared to the same period of 2008. In addition to growing revenues, the company also continued to broaden its customer base over the last year.
Management is tapping the company’s internal resources in order to take advantage of expected opportunities in the Electric Power and Transportation sectors. Despite this, operating cash flow remains positive, and the company has not needed to tap the markets for external financing since before the beginning of the financial crisis, demonstrating the ability to execute without external financing.
Overall, I consider the company’s balance sheet and cash flow to be excellent.
The company as too new of a publicly traded stock for me to determine if management has a habit of puffing results to shareholders. One sign of deceptive management practices are overly complex financial reporting structures. When I reviewed the last quarterly and annual reports, they did not seem to me to be overly complex, giving me a generally positive view of management’s honesty and straightforwardness.
The company had 12.6M fully diluted shares outstanding at the end of the quarter, 6 month earnings of $0.15 and a share price of $16.60. This translates into a P/E ratio of 55, which is extremely high, and would require phenomenal long term growth rates to be justified. The company has about $5 per share in annual revenues, giving it about a 3.3 price to sales ratio. This is not particularly out of line for a growth stock, but still higher than I am comfortable with.
Ruggedcom has a great business, a solid balance sheet, and I have found no reason to suspect management of incompetence or deception. However, given the current valuation, I have no interest in buying more, and continue to hold my current stake only because I am hedged against overall market moves. If a market decline were to lead to a significant drop in the stock price (as often happens with growth companies), I will look to acquire a substantial stake at that time, assuming the company’s fundamentals have not also weakened substantially.
DISCLOSURE: Long RUGGF.
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