Good time to get off the couch, get into Leon's

Fabrice Taylor, Chartered Financial Analyst, is a principal in Capital Ideas Research and writes the blog fabricetaylor.com

Leon's Furniture says it sells quality furniture for a good price. Its shares look like a good deal, too.

We looked at it in this space a year and a half ago and I figured that, although a great company, the stock wasn't outrageously cheap. It's cheaper now, while the company is worth more. This might be a good time to put some in your portfolio.

Leon's has been around for a century. It's family controlled, and they run a tight ship. They're conservative, they expand slowly, they don't make a lot of mistakes and they manage the finances well.

Let's look at the balance sheet as of Sept. 30. On the asset side, you have $507-million of value, about half of which is pretty liquid things like cash and marketable securities, accounts receivable and inventories.

On the liabilities side, you'll find no debt. The biggest item is payables, about $66-million, among other liabilities.

Book value - assets less liabilities - is $373-million, and the vast majority of that is retained earnings, or profits the company has earned and reinvested (that is, not paid in dividends). Why is that a good sign? Because it tells you the company is profitable. It also tells you it doesn't dilute its shareholders because equity consists of money earned and money raised from selling shares. Leon's buys back stock.

Book value now is probably about $5.25 a share.

Now the income statement: Leon's sales and earnings were down pretty sharply last year as you might expect, by $29-million or 5 per cent. Usually a drop in sales is accompanied by a much bigger drop in profits because it's hard to cut costs, especially quickly. That was the case for Leon's last year, as net income dropped 20 per cent.

But in dollar terms, despite spending more on advertising, Leon's made only $8-million less. I'd say there are some sharp pencils over there. The fact that it still earned good money in a very poor economy is a testament.

Now let's zoom out. Over the long term, Leon's has earned an average of 19 per cent on equity. It has done so with no debt, which gooses ROE. On average, the company seems to pay about 40 per cent of its earnings as dividends.

So here's one way of looking at it. Over time book value will grow by that ROE rate adjusted for dividends, which is roughly 12 per cent a year. You can gauge how much money the company will make per share and what the dividends will be over time (see table).

As things stand, with the stock at about two times book value, you'll earn a return of almost 10 per cent a year owning this thing if the past is a reliable indication. That may not sound like a lot but you're also not taking a huge risk: Remember, this is a 100-year-old company that's conservatively run. And a good portion of your return will be cash dividends. I think that's not a bad deal.

In fact, I'm not alone: BMO Nesbitt Burns just upgraded the stock to a "strong buy" based on a dropping stock price and improving conditions. The firm sees earnings of 83 cents a share this year - lower than our theoretical exercise, but keep in mind that ours is based on averages - and a stock price of $14 in a year's time, which is a 30-per-cent return with the dividend. Leon's currently trades at about $11.

BMO thinks a stronger Canadian dollar will help because it makes the stuff Leon's buys cheaper.

The nice thing about companies like this, which seem to have a long-lasting competitive advantage reflected in their returns on equity, is that you can buy them and forget about them.

Not many stocks give you that kind of peace of mind.