Today I bought 1500 shares of Solitron Devices (OTC:SODI) at $2.22/share with a $4.95 brokerage fee for a total of  $3334.95 investment. For someone maintaining a small portfolio this is a large investment. To paraphase Buffeet, if you have a high confidence in an investment bet the farm. This is a rare investment that qualifies into areas both as a Net Net stock and long term using a Discounted Cash Flow model. But I am getting ahead of the game.

I learned about SODI on a post on Net Nets at Old School Value, a terrific blog. There was some interesting analysis on his forum, by a young analyst from the Netherlands, named Floris. I started my own valuation and research then.

What is Solitron Devices? According to their latest 10Q SODI, “designs, develops, manufactures and markets solid-state semiconductor components and related devices primarily for the military and aerospace markets.  The Company manufactures a large variety of bipolar and metal oxide semiconductor (“MOS”) power transistors, power and control hybrids, junction and power MOS field effect transistors and other related products.  Most of the Company’s products are custom made pursuant to contracts with customers whose end products are sold to the U.S. Government.  Other products, such as Joint Army/Navy transistors, diodes and Standard Military Drawings voltage regulators, are sold as standard or catalog items.” In other words they are in the specialized semiconductor business.

Why would I be interested in investing in Solitron Devices?

First, They are are Net Net company. Not in the usual sense for me.  That is I don’t have the usual margin of safety I would require on a Net Net. I am valuing their Net Current Assets at between $3.08 and $3.50 per share. The difference is whether or not you take a traditional Graham approach (the higher amount) or  a modified Graham approach where you discount individual non cash accounts (the lower figure). One of the large differences is Inventories.

On Inventories, SODI is a little unusual, as they state “Inventories
Inventories are stated at the lower of cost or market.  Cost is determined using the “first-in, first-out” (FIFO) method.  The Company buys raw material only to fill customer orders.  Excess raw material is created only when a vendor imposes a minimum buy in excess of actual requirements.  Such excess material will usually be utilized to meet the requirements of the customer’s subsequent orders.  If excess material is not utilized after two fiscal years it is fully reserved.  Any inventory item once designated as reserved is carried at zero value in all subsequent valuation activities.”

This means that their inventories should not be discounted at the same rate that I ordinarily would discount them.

After calculating the NCAV value I estimate my buy price with a 33% margin of safety. This yields a buy price of between $2.03 to $2.31. As I have said I usually don’t drift above the more conservative of these figures. In this case I am accepting this as a range of acceptable valution , because SODI has other compelling reasons to purchase it.

Second, Despite the downdraft in the economy Solitron is profitable. That is an unusual statement for a Net Net company right now. Since I am not concerned about the immediate cash burn, this gives the company additional time for the market to “discover” the stock.

Third, I have evaluated SODI using a Discounted Cash Flow model and the stock is an attractive value. To value it using this method. I assume a negative growth of 6% (the past quarters) for the next year, then a 2% growth for the year after that, then back to 90% of trend, until terminal rate of 3% after 10 years. I then discount it by the rate  of return I want to achieve 20% (Yes, I know that is high, but I have said repeatedly, I am not in this for my health.) This gives me an intrinsic value of $5.38 – $5.94 depending on how you do the calculations. To achieve a buy price. I again apply a margin of safety. Because this is not asset driven but future earnings, I use a higher margin of safety:50%. That gives me a buy price of beloew $2.69 to $2.97. Solitron again passes the test.

Fourth, SODI has   “net operating loss carryforwards of approximately $16,582,000 that expire through 2023.” Given the low level of current profitability this is not a big asset particularly since it would be limited in the event of the sale of Solitron Devices. “Should a cumulative change in the ownership of more than 50% occur within a three-year period, there could be an annual limitation on the use of the net operating loss carryforward.”

Fifth, Solitron Devices doesn’t seem to be on anaylsts radar because it is so small. I like it when companies I am interested are not yet covered (and at this market cap, it could take a while) because you are more likely to find an untapped value.

Sixth, Unlike a lot of these small companies this company has not got a lot of negative scuttlebutt. Most people agree that it is undervalued because it is beneath the radar.

What are the Cons to buying Solitron Devices or at least the risks?

First, I don’t understand what their technology is or how quickly it is obsolete, which is why the way the company deals with inventories was very important to me. I would ordinarily discount inventories of tech stocks extra.

Second, Approximately 50% of SODI’s business comes from two clients. If one or both cease to need their products or those companies have financial problems, SODI could have big problems.

Third, We are in a recession, there is no telling how long it will take for things to turn around and sales to grow.

Fourth, They ” are dependent on government contracts, which are subject to termination, price renegotiations and regulatory compliance, which can increase the cost of doing business and negatively impact our revenues.” Who can guess what the government will be doing next.

On balance this seems like a stock you load up on and wait until it is discovered.

Disclaimer: As I stated earlier, I have purchased shares in the company I am writing about. I could sell those shares at any time, but I may not post about it immediately for a variety of reasons, including I have a day job that is not in the financial business. I am not a professional Financial consultant. I am a part time investor and full time Film and television producer. I buy and sell for myself only. No one should buy or sell any investment based on what someone writes on the internet,including me. You should do all your own research, as I have, to verify facts, and do your own calculations to come up with your own valuations of a company. Your mileage may very.

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