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Technical Communications Corporation (TCCO) Investment Valuation

October 18th, 2012 Posted by Investment Valuation No Comment yet

Technical Communications Corporation (TCCO) has specialized in providing military-grade secure communications systems and customized solutions and services that protect highly sensitive voice, data and video information transmitted over a wide range of networks, for more than 55 years. TCC’s solutions are optimized for cryptographic strength, performance, and ease of use, supporting our CipherONE® Optimized Network Encryption best-in-class criteria. TCCO website

TCCO was founded in 1961 and headquartered in Concord, MA. Registered under NASDAQ.

Value Investing Approach on TCCO

This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. The essence is that any investment should be purchased at a discount, meaning the true value should be more than the market value. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.

The Investment in Enterprise Value on TCCO

The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value EV) is the present value of the entire company.  Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash.

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

TCCO EV

Explanation

The market value of  Technical Communications Corporation was erratic in its movement at -19, -12, 235, -44 and -23 percent from 2007 to ttm6 2012, with an average of 23 percent. While the enterprise value, on the other hand, was at -40, -67, 1300, -64 and 40 percent with an average of 195 percent. Total debt was zero, thus, resulting in a no-debt-equity ratio of zero. Its cash and cash equivalent were 51 percent of the market value or 103 percent of the enterprise value.  Buying the entire business of TCCO will be equivalent to 100 percent equity.

The current market capitalization to date, October 16, 2012, was $10.5 million at $5.85 per share.  Buying to date will cost $6.5 million at $3.25 per share, this factors cash and cash equivalent.

Benjamin Graham’s Stock Test

Net Current Asset Value (NCAV) Approach for Technical Communications Corporation

The Net Current Asset Value (NCAV) is a method from Benjamin Graham it is to identify whether the stock is trading below the company’s net current asset value per share, specifically two-thirds or 66 percent of net current asset value. Meaning they are essentially trading below the company’s liquidation value and therefore, the stocks are trading in a bargain, and it is worth buying.

TCCO NCAVPS

The net current asset value approach for TCCO tells us that, the stock traded at an overvalued price from 2007 to ttm6 2012, because the result of 66 percent of NCAVPS was below the market value. Therefore the stocks did not pass the stock test of Benjamin Graham. In other words, the stock was trading above the liquidation value of TCCO, meaning, the price was expensive.

Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation  

Another stock test by Graham is by using market capitalization and dividing it to net current asset value (NCAV).  The idea is, if the result does not exceed the ratio of 1.2, then the stock passes the test for buying.

Another net current asset value approach was the MV/NCAV valuation. It shows that during 2007, 2008 and 2010, the price was overvalued because the ratio exceeds 1.2. On the other hand, during 2009, 2011 and ttm6, the price was undervalued because the ratio did not exceed 1.2. It tells us that in the current year, 2011 and ttm6, the stocks of TCCO was trading at an undervalued price, thus indicating that the price was cheap.

Benjamin Graham’s Margin of Safety (MOS)  

The margin of safety is used to identify the difference between company value and price. Value investing is based on the assumption that two values are attached to all companies – the market price and the company’s business value or true value. Graham called it the intrinsic value. The difference between the two values is called the margin of safety. According to Graham, the investor should invest only if the market price is trading at a discount to its intrinsic value. Value investing is buying with a sufficient margin of safety.

The question is, “How large of a margin of safety is needed for a stock to be considered a true value investment?” Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. The enterprise value is used because I think it is a much more accurate measure of the company’s true market value than market capitalization.

TCCO MOS

Explanation

The margin of safety evaluation shows that there was the margin of safety for TCCO at 80 percent average against the intrinsic value.  MOS was very high in 2010 at 99 percent, while intrinsic value goes up at a rate of 2850 percent, same period.

Let us find out why the intrinsic value soared up that high in 2010. Let us make a little digging here by going through to the next table below.  Before that, let me show you how the intrinsic value was calculated and the explanation for the calculation:

Intrinsic Value = Current Earnings x (9 + 2 x Sustainable  Growth Rate)   

The explanation for the calculation of intrinsic value was as follows:

EPS is the company’s last 12-month earnings per share;   G: the company’s long-term (five years) sustainable growth estimate;  9: the constant represents the appropriate P-E ratio for a no-growth company as proposed by Graham  (Graham  proposed an 8.5, but we changed it to 9); and 2: the average yield of high-grade corporate bonds.

Sustainable Growth Rate (SGR)

As we have mentioned earlier, that intrinsic value is the real value or the true value of the stock.

TCCO SGR

The above table shows that in 2010 the sustainable growth rate was high at $62.17, an increase of 425 percent from 2009, and it’s earning per share (EPS) soared up by 620 percent. To make us understand more, let us see what factors these two ratios. The calculation for EPS was as follows:

TCCO EPS

EPS factors net income and the number of shares outstanding. The net income of TCCO soared up too, by 700 percent from $1 to $8 million and resulting in $4.68 EPS. Now, let us see what factors sustainable growth rate. Please walk with me, let us see the table below for the calculation, let us dig a little more.

Sustainable growth rate factors return on equity and payout ratio. The formula for ROE was shown below:

Return on Eqquity (ROE)

TCCO ROE

The return on equity increased by 454 percent in 2010 because the net earnings soared up high too, obviously, we get a high result of sustainable growth rate, which resulted to a high annual growth rate and high intrinsic value.  This is the reason why the margin of safety was high in 2010 for TCCO. I hope I have guided you well.

There are two approaches to calculating the sustainable growth rate. By using the relative return on equity and the other one is by using the average return on equity. The table below will show you the difference between the two approaches.

TCCO Relative

Explanation

The table shows, using the relative return on equity produces a higher result for TCCO. Using the average ratio is taking into consideration the past period’s performance; the ROE was negative in 2006 at -$2.49, thus giving us a lower ratio in 2007. Therefore the result was lower in using the average approach.

Look I saw a graph below and here goes again my questioning side as what the graph means.  I would like to explain to you further the relationship between the intrinsic value or the true value of the stock and the price. The graph below will make us fully understand the meaning of margin of safety. Please walk with me.

TCCO Graph

Explanation

The enterprise value, as to what Cris’s said, was constant at an average of 6, while the intrinsic value has an erratic figure or movement. In 2010, the true value of the stock of TCCO soared up very high as a percentage of 2850 percent. The space between the IV line (red line) and the EV line (blue line) is the margin of safety.  As we can see the MOS was very high at a percentage of 99 percent, but during the trailing twelve months, there were zero margins of safety because the intrinsic value was lower than the price. This is how we get the margin of safety for TCCO.

TCCO Relative Valuation Methods  

The relative valuation methods for valuing a stock are to compare the market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

Price to Earnings/Earning Per Share (P/E*EPS)

This method will determine whether the stocks are undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share, we can determine the status of the stock price.

TCCO PE EPS

The price to earning*earning per share (P/E*EPS) valuation tells us that the stocks were trading at the undervalued price from 2007 to ttm6, because the enterprise value per share was lower than the result of P/E*EPS, therefore the price was cheap.

The enterprise value per share was $2.92 average, while the P/E*EPS was $4.48 average, telling us that price was lower than the result of the valuation. There is another approach in calculating this valuation, and that is by using the average price to earnings ratio rather than the relative ratio. I have made a comparison between the two approaches.

Using the average approach produces a higher percentage of P/E*EPS, this means that the price is more undervalued than by using the relative approach.

Enterprise value (EV)/Earning per Share (EPS) or (EV/EPS)  

The use of this ratio is, to separate price and earnings in the enterprise value. By dividing the enterprise value to projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).

Technical Communications Corporation

In EV/EPS, the price was -341 percent, while the earnings the EPS was 441 percent, net of 100 percent. The percentage of price was negative because the EPS during the trailing twelve months was negative, there were no net earnings during this period and EPS factors net income.

Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA).

This metric is used in estimating business valuation.  It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries.

TCCO EV EBITDA

The EV/EBITDA indicates that it will take 1 time or 1 year to cover the costs of buying TCCO. The company had average net earnings of 16.51 percent and EBIT of 19 percent.

It shows that the company is capable of generating sufficient revenue for its business operation. With its sustainable growth rate of 20.27, the annual growth rate of $49.55. Moreover, a return on equity of $21.41 average, shows a favorable sign of TCCO’s strength.

In conclusion, 

The market value of the TCCO was erratic in movement. The company is a no-debt-equity ratio of zero, cash and cash equivalent was 103 percent of the enterprise value. Buying the entire business of TCCO is buying 100 percent of its equity. The current market capitalization to date, October 16, 2012, was $10.5 million at $5.85 per share.  Buying to date will cost $6.5 million at $3.25 per share.

Graham stock test indicates stock was trading at an overvalued price. Because the price was over 66 percent of the NCAVPS. The stock was trading above the liquidation value of the company. Therefore it did not pass the stock test of Benjamin Graham.  While in MV/NCAV the price was overvalued because the ratio exceeds the 1.2 ratios.

The Margin of Safety (MOS)

On the other hand, the margin of safety indicates an average of 80 percent of the intrinsic value. Further, the intrinsic value soared up high at 2850 percent in 2010 in one year.  The income soared up high at 700 percent in 2010. The sustainable growth rate was $20, while the annual growth rate was $50. In addition, the return on equity was $21, a favorable growth for TCCO.

Furthermore, in the P/E*EPS was undervalued because the price was lesser than the P/E*EPS result. Using the average price to earning approach, the P/E*EPS percentage was higher by 3 percent. While the EV/EPS valuation shows that the price was -341 percent and the earnings was 441 percent. It shows a negative result for the price to earnings because the earnings in ttm6 were zero.

EV/EBITDA

Moreover, the EV/EBITDA indicates that an investor will wait one year to cover the costs of buying the entire business. This shows that TCCO is capable of generating sufficient revenue for its business operation.

TCCO shows a favorable growth and a margin of safety of averaging 80 percent. However, the current margin of safety was zero, I, therefore, recommend a HOLD in the stock of the TCCO.

Research and Written by Criselda

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Research Reports can be found under the company tab.