One way to find ideas among the thousands of publicly traded stocks is to look at the holdings of mutual or hedge funds that invest the same way that you do. Whitney Tilson runs Kase Capital, a small value-orientated hedge fund, formerly known as T2 Partners. Kase has some positions that many hedge funds seem to have, like Netflix, Inc. (NASDAQ:NFLX) and Berkshire Hathaway Inc. (NYSE:BRK-B), but there are also some more interesting stocks that I knew nothing about before discovering them in Tilson’s portfolio. Let’s take a deeper look at three of these less-followed companies.
Canadian Pacific Railway Limited (USA) (NYSE:CP) is a railroad operating in Canada and the United States. The company suffered negative free cash flow from 2009 through 2011, before returning to positive territory in 2012. The stock has almost doubled from its 52-week low, and at 45 times earnings looks outrageously overvalued.
Last year Pershing Capital, after taking a large stake in the company, was able to get the CEO to resign and replace him with Hunter Harrison, named “Railroader of the Year” in 2002. The hope, apparently, is that the new leadership can make the company more profitable. Canadian National Railway (USA) (NYSE:CNI), a larger company with almost twice as much revenue and more than five times the net income, is only trading at 15.8 times earnings.
It seems like Canadian Pacific Railway Limited (USA) (NYSE:CP)’s stock price is being supported by hope more than anything else. Let’s say, for instance, that net income triples over the next ten years. This would mainly come from margin expansion, since Canadian National Railway (USA) (NYSE:CNI) has a net income margin more than three times that of Canadian Pacific Railway Limited (USA) (NYSE:CP). This would put the P/E ratio, using today’s market price, at about 15. Railroads aren’t really fast growing companies on average, so I would be reluctant to pay much more than 15-20 times earnings for even the best railroad. Canadian Pacific Railway Limited (USA) (NYSE:CP) is trading at a price which assumes this turnaround has already happened. It hasn’t. And 45 times earnings is an absurd price to pay.
Howard Hughes Corp (NYSE:HHC)
Howard Hughes is a real estate company that specializes in master planned communities, as well as some other real estate properties. In the most recent investor letter Tilson estimates the intrinsic value of Howard Hughes to be as much as $125 per share, well above the current market price of about $82 per share. This company is not very well followed, with only a single analyst covering it, so the chances that the stock is mis-priced are higher than a more well-followed stock.
Being a real estate company, the book value of the company’s properties most likely understates the true value. Tilson has some slides here that detail how he values the different properties and how he comes up with the $125 per share estimate. The theme seems to be that the properties are very difficult to value, but it is almost certain that the true value is higher than the book value. Currently the stock is trading at about 1.4 times the book value, but for a time last year it was trading well below the book value.
HHC Price / Book Value data by YCharts
I think it’s safe to say that the stock is very likely to be a bargain at a price below the book value.
Spark Networks Inc (NYSEMKT:LOV)
Spark Networks owns a series of niche-dating sites such as JDate.com, BlackSingles.com, and ChristianMingle.com. JDate is the most mature site, with a generally flat subscriber count of about 85,000 members. ChristianMingle has been growing quickly, with Q4 revenue up 76% year-over-year.
The idea of a niche dating site certainly makes sense, but by its nature growth is limited. The company recorded $61.7 million in revenue in 2012 and a net loss of $15 million. It appears that JDate, on its own, is profitable, but the newer sites like ChristianMingle are dragging down profitability. The stock has surged for some reason since the beginning of 2012, and the company is now valued at $150 million.
The problem with dating sites is that once a customer finds someone they stop using the service. In a way, the better the site is at matching people the shorter time people stay customers and the worse the company does. And since the market for these niche sites is small to begin with, growth is very limited and saturation occurs quickly. It seems like a lot has to go right for Spark to be a reasonable investment here, and I don’t think it’s worth the risk.
The bottom line
Of these three stocks in Tilson’s portfolio I only like one – Howard Hughes. The other two, Canadian Pacific and Spark Networks, both seem like pretty big gambles to me. It’s one thing to buy a troubled company, but to pay an exorbitant price for one seems like a bad idea. At the very least Tilson’s portfolio has introduced me to a few companies which I didn’t know anything about before, and that’s always a good thing.
The article Finding Ideas In Whitney Tilson’s Portfolio originally appeared on Fool.com and is written by Timothy Green.
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