Caseridge Dealbook: The Quick and Dirty

Caseridge Capital’s Adam Adamou suggests investors focus on value and liquidity as we head into what he expects will be a more volatile third quarter.

The Quick and Dirty…

An interesting trend has developed over the last thirty days and is highlighted this week in the aggregate numbers and multiples on pages five and six of this report: aggregate valuations are declining as aggregate multiples are expanding. This means that even as the stocks in the 250 company Caseridge TechSys Index have been flat to only slightly positive over the last thirty days (and negative over the last week), the valuation multiples are actually increasing, which of course implies that the index is more expensive even as it declines.

To be blunt, we don’t like this trend. At present the proprietary Caseridge GMM multiple is at 1.21 (as at August 21st) based on an average date of the trailing financials of May 16th. As more financial information from the second quarter enters into our model we are seeing greater and greater declines in revenues and gross profits. These declines lead to higher multiples in a flat to positive market, and even in a down market in which the rate of decline in the financials is greater than the rate of decline in the valuations.

At the present GMM multiple of 1.21 we believe that the market is pricing in an aggregate gross profit growth rate of 21% between May 2009 and May 2010. We are not prepared to sound off the alarm bells just yet: as we have mentioned in the past, the second quarter is likely to be the trough quarter of the recession and markets being forward looking mechanisms are now adjusting to better expected numbers in the third quarter and beyond. It’s doable, but it’s no easy task and it comes with some considerable risk of a downward slide should growth prove to be more anemic than expected.

Our advice to clients at this point is to stay focused on value and liquidity. We believe that the companies at greatest risk of being both overvalued and of disappointing us in the next twelve months are those with gross margins of less than 30% and we would advise clients to steer clear of them for the time being. Look for companies with strong and stable gross margins and whose price performance has lagged somewhat over the last thirty to sixty days.

I believe that we’re going to have an interesting third quarter in the markets that will be highlighted with some greater volatility. At this point I would look to play some defense – hold on to your gains and look for opportunities. If you’ve been following this report then you’ve already scored the goals needed to win, it is now time to focus on not giving them up late in the game.

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We hope that you enjoy this weeks’ Caseridge TechSys DealBook.