Aiming For $6

We do pretty well here at The Kelly Letter, and one key to that is patience. Longtime subscribers know that the letter’s favorite action is inaction.

We watch. We take notes. We watch more. The price falls. Other letters issue buy alerts. We watch longer. The news gets worse. Other letters stop out. We watch longer. The management team gets fired or the SEC initiates a probe. The price drops dramatically. The letters that got stopped out write about how awful the stock is and, thank goodness, they stopped out before the damage got too bad. Then we buy. The stock bases, trickles higher, then the news improves, the stock rushes upward, and the momentum gang comes aboard. By then, we’re up dramatically.

That pattern has played out time and again for us. It’s not for everybody. A lot of online investors are looking for a fast buck, the quick trade, the flip-flop-til-you-drop lifestyle that usually ends in two things dropping: your net worth and your life expectancy.

That approach (A) doesn’t work and, (B) is no fun at all. The reason it dominates investment services is that it creates a dependency that keeps subscribers coming back for more. If you can be persuaded to think that you must have “split second timing” to succeed in the market, and that a certain subscription service can provide you with that timing, you’ll fork over the exorbitant subscription fees as a business expense. What’s $150 per month when you stand to make thousands off the calls?

As a publisher of investment information, I know well that such an approach works for the publishing company. “Scare the money out of ‘em,” is how one publisher explained his approach to me at a conference. Another told me that none of us know any more about the market than our subscribers, but we’re good at making it look like we do, and subscribers believe we do. A third said simply that the most important writing he ever does is for advertising.

What a crock, I say.

Here at The Kelly Letter, we want subscribers who not only believe in what we do, but actually use it, and stick around because it works. Let’s be honest. Most people are not capable of, nor interested in, the frenetic trading that most services advocate. Most people want to place, maybe, three or four trades per year, and watch their money grow steadily over time as a result of that. Not only is that simply the reality of how most investors behave, it’s a better way to invest.

With that in mind, I would like to share with you some information about a stock we’ve been watching for a long time. I won’t tell you its name, because that would be unfair to current subscribers who pay the rich sum of $5.48 per month (yes, that’s all), but I will show you pertinent details about it so you can understand how things operate around here.

Now, of course I know that you can spend time researching key words and find out the name of the company on your own, and use this free info to take action without subscribing to The Kelly Letter. That’s fine. What I’d prefer, though, is that you see what kind of turnaround stories are attractive to us, what we look for, and what you can expect to read about should you take the bold step of paying a penny to try the letter for a month.

Onto the company.

We love turnarounds. It’s in our blood to root for the underdog, to see a fighter get up off the mat and signal that he’s not done, to watch the once proud stumble and prove their mettle by regaining former heights. The risk of such predilection in the stock market is that you’ll buy into a value trap. That’s a stock getting cheaper not because of temporary problems, but because of real problems that won’t go away and that might finish the company. Anybody who bought “cheap” shares of New Century Financial, which is now bankrupt, knows what I mean.

To avoid value traps, we watch for a long time. To most internet investors, that’s more than three days. We’re still on the old clock, though, and to us long means weeks, months, and, in one very profitable case, years. That’s right, we watched a stock for years before buying and it just kept going lower until it went sideways, its margins improved, its forecasts went up, we bought, and the line turned upward.

This stock that I’m writing about today is another turnaround. We’ve been watching it since it imploded in the disaster of 2000-2002. In October 2000, it hit $85. At the end of January and March of this year, it dropped briefly below $6. It closed yesterday at $6.29. We want to buy it at or below $6.

Is it a value trap? Is the company’s potential gone? We don’t think so. In fact, the stock has been on a decline for years because the company was investing a lot of money in its recovery, and finally the pieces are in place and analysts are forecasting an improving earnings trend.

Here’s a free tip: you have to buy before things get better. If you wait until they’re already better, you’ve missed a large part of the recovery. As Warren Buffett famously put it, you pay a high price for a cheery consensus. In general, people still hate and/or doubt this company, which is the norm for what interests us.

Below are excerpts from the company’s recently filed form 20-B. As you read through these, ask yourself if this stock could possibly stay at around $6 for long. Ask yourself, “Is this a value trap, or is there unrealized potential here?”

Through our global manufacturing network, we provide a range of services and solutions to OEMs in the communications, computing, industrial and consumer sectors.

We have operations throughout Asia, the Americas and Europe. In 2006, approximately one-half of our revenue was produced in Asia and one-third of our revenue was produced in North America.

We believe we have a competitive and strategic global manufacturing network. Approximately 85% of our employees at year-end were located in lower-cost regions. Many of our sites have significant technical capabilities, which we believe differentiates us from our competitors. This is complemented by some higher-complexity manufacturing and service offerings provided by sites in higher-cost regions.

During the past few years, we have increased our penetration into the industrial market, which includes aerospace and defense, and the consumer market. This diversification has enabled us to reduce the risk associated with reliance on only a few sectors. We now supply products and services to over 100 OEMs.

Our two largest customers in 2006 were Cisco Systems and IBM, each of which represented 10% of total 2006 revenue and in aggregate represented 20% of total 2006 revenue. Our top 10 customers in 2006 represented 59% of our total 2006 revenue. We expect to continue to depend upon a relatively small number of customers for a significant percentage of our revenue. To reduce this reliance, we have been targeting new customers in the industrial and consumer markets.

The products we manufacture can be found in a wide array of end products, including networking, wireless, telecommunications and computing equipment; handheld communications devices; peripherals; storage devices; servers; medical products; audio visual equipment, including LCD televisions; printers and related supplies; gaming products; aerospace and defense electronics such as in-flight entertainment and guidance systems; and a range of industrial electronic equipment.

Our principal competitive advantages include our advanced capabilities in the areas of technology and quality, our flexible and low-cost manufacturing network, our broadening service offerings, and our market-focused supply chain management strategy.

We are still not operating at our target levels. We will continue to focus on:
(i) significantly improving the operating and financial performance in Mexico by improving its manufacturing and warehouse logistics, and implementing our best supply chain and materials management practices,

(ii) restoring the profitability in Europe by reducing our overhead costs and growing our revenue base, primarily in the communications segment,

(iii) completing our restructuring programs ensuring we have the appropriate global manufacturing network and supporting cost structures in place to serve our customers,

(iv) leveraging our best supply chain practices globally to lower material costs, minimizing lead times and improving our planning cycle to better meet changes in customers’ demand, all of which should lead to increased asset utilization, and

(v) compensating our employees based, in part, on the achievement of profitability, return on invested capital and customer satisfaction targets.

In order to drive greater efficiency, we are also committed to the continuing deployment of Lean and Six Sigma initiatives, designed to simplify and to improve manufacturing efficiencies by reducing waste and redundancy and to improve quality within our manufacturing facilities. We will continue our intensive focus on maximizing asset utilization, which we believe will, when combined with the margin enhancement measures described above, increase our return on invested capital.

During the period from 2001 to 2003, the EMS industry experienced significant demand weakness, particularly in the computing and telecommunications end-markets, as spending on higher-complexity and infrastructure products was reduced. Our concentration of business with customers in these end-markets had a significant adverse effect on our revenue and margins for 2002 and 2003.

In response, we initiated restructuring plans to rebalance our global manufacturing network and reduce capacity. During the technology downturn, the EMS industry began a major transformation of its manufacturing network. OEM customers wanted their EMS providers to shift more production to lower-cost regions in an effort to lower their product costs and allow them to better compete in highly competitive markets.

In 2001, we announced our first restructuring plan. As the downturn continued, and excess capacity in our higher-cost geographies remained, we announced additional restructuring plans that took place through to 2006. These restructuring plans were focused on consolidating facilities, improving capacity utilization, increasing production in lower-cost geographies and accelerating margin expansion. Our capacity utilization in the fourth quarter of 2006 was approximately 60%, down from approximately 65% earlier in the year. Approximately 85% of our employees at December 31, 2006 are in lower-cost geographies, up from approximately 60% at the end of 2002.

Although we completed 2006 with revenue higher than in 2005, our operating margins eroded year-to-year, primarily due to operational challenges in our facilities in Mexico and Europe. The performance in Mexico also impacted our inventory and our customer satisfaction levels during 2006. Our priorities for 2007 are as follows:

  • restore customer confidence and improve our operational and financial performance in Mexico

  • return Europe to profitability by generating more business with European OEMs, particularly in the communications segment

  • increase our asset utilization, and in particular our inventory turns

  • drive efficiency through simplicity and the elimination of waste by reducing our overhead structures, streamlining processes and continuing to foster a Lean culture

In an effort to simplify our operations in Mexico, we are transferring certain customers to our Asian facilities and disengaging with certain non-strategic customers that were adding to the complexity of our operations.

A $6 stock? We don’t think so, and that’s why we’ve been watching it for so long and are preparing to buy should it get below $6 again.

We might watch longer, but probably not much. We recently made two purchases, one of which is up slightly from our buy price and one of which is down slightly. In the end, however, we’re almost always right. We think the company profiled today will prove profitable if bought below $6, and it’s showing every indication of getting under $6 at least one more time.

We don’t take many actions, and the actions we do take don’t require split-second timing, but when we do something, we make money. Because our view is so long and patient, we charge a nominal subscription fee of just $5.48 per month so you can feel comfortable biding your time with us. Years with us are cheaper than months at competing publications — or even weeks, in some cases. Paying those kinds of prices is just plain nuts, particularly since their hyperactive approach is proven to be less effective than a slow-and-steady approach.

To find out more about the stock discussed above, our market-beating permanent portfolios including the famous Maximum Midcap (up 15% so far this year), and our current individual open positions, just scrounge up a penny you don’t need and sign up for our one-month, one-cent trial.

If you’re looking for lots of fast trading tips, please don’t sign up. We can tell you right now that you’ll be disappointed and, frankly, it’s not worth our time to get you started.

If, however, you’re looking for a long-term companion in the profitable adventure that is the stock market, give us a whirl. If you don’t like what you receive, just cancel within the month and never pay more than the penny.

Thank you for stopping by and reading. I hope to see your name on our growing list of happy subscribers.

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