CE Franklin (CFK) has the makings of a terrific value stock. It has a history of fairly stable revenues and earnings, and appears to trade at a discount to those earnings. From an asset point of view, the company’s current assets cover all of its liabilities with enough room left over to cover the company’s market value. There’s just one problem: the company’s industry.
CE Franklin distributes industrial supplies to the oil and gas sector. While maintenance and repair supplies, even to this sector, can be fairly stable, half of the company’s revenue exposure relies on new capital spending by oil and gas companies. The amount of capital spending by oil companies can vary dramatically depending on the price of oil. While there are many who believe the oil price will rise again soon, and others who believe it will fall, there’s no reason to make a bet in either direction if you don’t have to.
Many intelligent people who follow the market will tell you that they don’t know which way oil prices will move, and that’s a perfectly fine position to take. We’re not interested in guessing, but rather in finding opportunities with strong upside potential with minimal downside risk. CE Franklin certainly has the upside potential, as it trades at a discount to its assets, and a positive move in oil prices will likely result in strong price appreciation. Unfortunately, the downside risk is not minimal, as falling oil prices will result in shelved capital projects that would bring revenues dramatically lower.
An important theme of value investing is that one does not have to take a position on every stock. While other analysts tend to believe a stock will either go up or go down, value investors are content to say “I don’t know” on a majority of stocks, and only invest in the ones they are relatively sure about.
Disclosure: None
