Disclosure: I am long ZAGG.
But as Warren Buffett says, the best time to be greedy is when others are fearful. And while most investors were shunning Zagg, my Guru Strategies -- quantitative models based on the approaches of different investing greats -- were issuing a Trade Alert for the Salt Lake City-based small-cap. These Trade Alerts are issued when a stock's fundamentals earn it certain level of interest from one or more of my models (usually multiple models are involved). Through back-testing, I've found that stocks that have had these characteristics in the past have tended to perform well over a subsequent period (usually the next three or six months).
In the case of Zagg, my Peter Lynch-, Kenneth Fisher-, and Joel Greenblatt-based models triggered the alert. Historically, when a stock has received strong interest from three of my models, it has gone on to gain an average of 7.6% over the next three months, more than tripling the average S&P 500 return of 2.2%. Such stocks have beaten the S&P nearly 60% of those occasions, with the best single performance involving a return of more than 160% over three months. The alert for Zagg was issued on May 22 and runs until August 21. Since it was issued, the stock is up 3.7% while the S&P has fallen 4.1%.
Challenging Times
To be sure, Zagg ($163 million market cap) is facing some issues. First-quarter earnings were about half what analysts were expecting, and revenues -- which were expected to jump by about 20% -- actually fell. But while some of the shortfalls were the result of misfires on new products, a chunk was also due to changes that caused short-term results to suffer, but should help over the longer term. Zagg, for example, changed its distribution strategy, deciding to align with three "master distributors" who were on board with the firm's pricing strategy, and sever ties with other distributors who'd been sharply discounting its products. It also consolidated its account management team, so that customers now deal only with one representative for its iFrogz and Zagg products, rather than dealing with separate reps for each brand. The firm said these changes caused some of the short-term weakness seen in Q1.
But looking forward, Zagg appears to have some very intriguing products that are getting strong reviews -- it recently won multiple awards from nonprofit industry group CTIA for several products. The group lauded Zagg for its ZAGGkeys Cover, a keyboard that attaches to iPad minis; its ZAGG Origin, a sound system that combines desktop and portable speakers into one unit; and its iFrogz Caliber Advantage, a game controller that attaches to the iPhone 5 and iPod Touch.
Strong Numbers
Just as importantly, Zagg's fundamentals and financials look solid, with its recent price decline making its valuation metrics quite attractive. Zagg shares now trade for just 1.35 times book value, quite low for a firm that deals in the tech arena. And using the net current assets to long-term debt metric that Benjamin Graham -- the "Father of Value Investing" -- used, it also looks attractive, with long-term debt of about $34 million and NCAV of $82 million.
Zagg also trades for just 0.62 times trailing 12-month sales, a big reasonmy Fisher-based model likes it. Zagg may be a great example of a company going through what Fisher called "the glitch" -- that is, a short-term growing pain that hurts earnings and scares off investors, but doesn't hurt long-term prospects. Fisher found the companies that go through a glitch often make for great investments. The trick, however, is figuring out how to evaluate a company when earnings are down in the short term. To Fisher, the answer was to look at sales, which he found to be far more consistent than earnings and a better indicator of a company's true strength or weakness. In his 1984 book Super Stocks, Fisher thus pioneered the price/sales ratio -- PSR -- as a valuation metric. My Fisher-inspired model considers PSRs below 0.75 to be quite attractive for noncyclical companies like Zagg, so Zagg appears to be a bargain. (Note that if we use projected 2013 sales -- which include lower guidance announced after the first quarter -- the PSR would be even lower, at 0.58.)
My Greenblatt-based model also sees a lot of value in Zagg. It looks at earnings yield to gauge value (though not using a simple earnings/price ratio; it instead divides earnings before interest and taxes by enterprise value). Zagg's earnings yield is about 19.9%, which makes it the 27th cheapest out of the thousands of stocks that I track. The Greenblatt-based model also likes that Zagg is generating a 38.2% return on capital, a sign that its business is strong. All in all, this model thinks that Zagg is one of the 40 most attractive stocks in the market right now.
Finally, while Zagg's growth has slowed recently, my Lynch-based modellooks at growth over a longer period. Using the average of the 3- and 4-year EPS growth rates, Zagg has a long-term growth rate of nearly 44%, which this model likes to see. Lynch famously used the P/E-to-Growth ratio to find bargain-priced stocks, and when we divide Zagg's 16.4 P/E (trailing 12-month) by that long-term growth rate, we get a PEG of 0.37. That falls into this model's best-case category (below 0.5). Again, even if we use forward-looking data (analysts are projecting a 22.5% long-term growth rate and Zagg's forward P/E is just 7.5), we still get a stellar PEG of 0.33.
Buying Amid Fears
Overall, these three models are indicating that investors are overreacting to Zagg's short-term problems. That's not uncommon. Throughout history, the best investors have taken advantage of the emotional reactions the masses have to short-term problems. Elite strategists like Fisher, Lynch, and Greenblatt made their fortunes and reputations in large part by having the conviction to pick up shares of good companies when these short-term hiccups drive less disciplined investors away. Right now, my strategies think that's just what's happening with Zagg.
By John Reese
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