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Forget analysts - it's managers who matter

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Flipping through reports from Bay Street investment analysts recently, I came across one that was sadly typical. Looking at a medium-sized company, the analyst raised his gross margin estimate, lowered his forecast tax rate, tweaked his earnings estimate and adjusted the price-to-earnings multiple. The result? A slightly higher share price target of $9.36 and no change to his "strong buy" rating. The stock was trading at about $8.60.

I had to shake my head. If you're impressed by highly optimistic estimates that are carved with such a sharp scalpel, you shouldn't be investing.

My view, born of experience and scars, is that investing is less about numbers and more about behaviour. If people know a company better than you do—and if they're CEOs or industry insiders, that's usually the case—follow them and you'll make money.

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A case in point: The Brick Ltd. furniture chain, founded in 1971 by Bill Comrie. In 2004, Comrie cashed out part of his stake by converting the private company into an income trust. The trust did okay until the 2008 financial crisis, when sales plummeted and it ran out of credit to finance inventory. Its unit price sank from more than $8 in June, 2008, to less than $1 in early 2009.

Then the company announced that it had arranged warrant offerings with Comrie and some very savvy value investors. The warrants gave holders the right to buy new trust units—a lot of them—for a very cheap price. The warrants were terribly dilutive to existing shareholders, but the $120 million the company raised helped save it.

You didn't need an abacus, spreadsheet or calculator to plunge into the units. In fact, you didn't need a single number. Comrie put millions into the deal, and no one understands the Brick and its business better than him. Sure enough, the unit price more than doubled by early 2010.

Migao Corp. is another useful example. The company is headquartered in Toronto, but it manufactures fertilizer in China. Its share price plunged by more than a third in June because of two developments: One was worries over an agreement to buy 10 years' worth of discounted potash supply from some obscure Russian manufacturers. The hitch was that Migao had to prepay $100 million (U.S.) to sign.

The second was the collapse in the share price of Sino-Forest Corp. in June after a U.S. short seller alleged that the company is a fraud. Like Migao, Sino-Forest is headquartered in Canada, but it operates in China.

Migao CEO Guocai Liu moved fast. Liu owns a lot of company shares, and he bought more, as did directors and another executive. Liu also pledged that if the Russian suppliers don't deliver, he'll lose his stock. Granted, this story is a little hairy, but fertilizer is a good business, and Migao has actual factories. It might be possible to fool analysts by showing them a forest and claiming it's yours; it's probably harder—even in China—to show them a chemical factory and claim it's yours. At about $4.50 recently, Migao's share price is also attractive—just five times earnings.

Even without numbers, watch for signs of intelligence among executives and industry insiders. You can't calculate exactly how useful or accurate those signs are, but that's a good thing.

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VALUE Bennett Environmental Inc. Trailing price/earnings ratio 11.1 Bennett's share price sank from $28 to less than $2 in the mid-2000s as it dealt with a regulatory scandal and withering demand for its soil remediation services. But the company has an incineration plant in Quebec that makes lots of money when it's running, $60 million in the bank and an energetic new CEO and board. Value investing guru Irwin Michael now owns 18% of Bennett. He's not in it to make an average return.

GROWTH New Gold Inc. Three-year revenue growth 338% Do you ever think you're the only sane person in the room, town or world? Do you watch gold prices soar, leaving gold miners' share prices in the dust? Investors apparently don't understand that producers sell bullion for that increasing price, and that there's inherent leverage in shares compared with the metal. New Gold has hefty cash flow, and five years from now, even at lower gold and copper prices, it could be generating about $2.60 a share. Using historical industry price multiples, that implies a stock price of $39, versus New Gold's recent market price of about $10. Wake up and smell the returns, people.

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About the Author
Investment Columnist

Fabrice Taylor, CFA, publishes the President’s Club investment letter, for which he and The Globe and Mail have a distribution agreement. More

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