Harte-Hanks, Inc. (NYSE:HHS)

CAPS Rating: 3 out of 5

A direct and targeted marketing company that provides direct marketing services to a range of local, regional, national and international consumer and business-to-business marketers.

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4
Player Avatar notzia (70.93) Submitted: 5/28/2009 1:49:43 PM : Outperform Start Price: $5.68 HHS Score: -116.22

The analysis presented is based on a current price of $6.92.

The most concerning aspect of this stock is that the EPS is not growing much; for the 2001-2006 period, the compounded annual growth (CAGR) has been 11%, but extend the period to 2008 and CAGR drops to 3%. Nonetheless, the return on equity (ROE) has exceeded 15% since 2002 (exceeding 20% in 2005, 2006, and 2007), and the free cash flow has been positive since 2001 and generally increasing until 2007 and 2008.

Before I look at the valuations, I look at three indicators of financial safety. For this stock, all three are quite good. The Altman Z is 4.1; below 1.8 is risky, above 3 is the safe range. The Piotroski F is 6; 2 or below indicates caution, while 8 or 9 indicates that the stock is expected to rise within the next year. The Sloan accrual is -6.31; 5 or higher is high risk, while -5 or lower is excellent.

I use more than one valuation method to gauge intrinsic value; the first three all provide a good margin of safety (MOS). The first three are standards in the valuation literature. The estimate based on Graham’s formula was $18.45 (55% MOS), though if I increase the growth from 3% to 11% based on the discussion above, the estimate becomes $37 with an 81% MOS. The Earnings Power Value (value of the firm) was estimated, on a per share bases, to be $23 (70% MOS). The Discounted Cash Flow estimate valued the stock at $40 (83% MOS).

The last two were based on a spreadsheet found on the AAII website; these are designed to mimic Buffett’s valuation methodology. One is based on projecting EPS growth 10 years into the future based on past EPS growth; I discount the resulting valuation to reflect the price at which the stock will realize a compounded earnings (including dividends when applicable) return of 15%. The results of this method, even when the EPS growth is increased to 11%, do not recommend purchase of this stock.

The second is based on estimating EPS growth through the sustainable growth rate. The per-share projected book value is estimated by taking the previous year’s book value, adding EPS and subtracting dividends (when applicable). The projected EPS is estimated by multiplying the projected book value by the average Return on Equity, and the projected dividend is estimated by multiplying the projected EPS by the average payout ratio. I then discount the resulting valuation to reflect the price at which the stock will realize a compounded earnings return of 15%. Based on this method the target purchase needs to be below $7, and at the current price there is an 3% MOS

To ascertain that the price is attractive to me, I take one more thing into consideration. At the current price, would I expect an immediate 15% return on my investment (ROI) based on earnings and dividends? In this, the EPS represents about 14.2% of the share price by itself, so the 4.3% dividend yield is needed. However, because the dividend was needed to achieve the desired 15%, I also consider the risk that the dividend may be cut. This risk is assessed by evaluating several factors (Current Price, Current Yield, Current Payout Factor, Gross Margin, Operating Margin, Financial Leverage, EPS Growth). Based on this assessment, there is a moderate (most recent fiscal year) to moderate (TTM) risk that the dividend may be cut. Although greater weight is given to a TTM assessment, there is still enough certainty that the dividend will still support a 15% ROI.

Because there are many stocks that meet all of my criteria, I will not actually invest in HHS at this time. However, for CAPS purposes, I feel that it will outperform the market as a whole and make a caveat-filled recommendation.

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Member Avatar jmontgomery86 (66.25) Submitted: 5/30/2009 3:04:03 PM
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I have to agree with you on the analysis. My question for you is, how did you figure out the estimated value of the stock and the margin of safety percentage?

Member Avatar notzia (70.93) Submitted: 6/2/2009 10:05:21 AM
Recs: 0

There are a number of books that describe the formulas, and there are a number of websites that have spreadsheets that you can plug the numbers into. A good place to start is www.oldschoolvalue.com and the Stern School of Business website.

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