QLTI – a Graham value play experiment

I purchased some shares of QLTI today in what is basically my first attempt at putting Benjamin Graham’s value investing approach for “enterprising investors” at work. Given the drop in stock prices the last few months, various screens showing stocks trading at 2/3 net current asset value (or NCAV) have suddenly shown dramatic increases in listings versus in “normal” times.

I found QLTI through a 2/3 NCAV screen at Fat Pitch Financials’ Contributors Corner, of which I’m a subscriber. Note that again, there are many different Graham stock screens available, each of which may show a different set of stocks based on definitions and criteria. I narrowed down the list from FPF’s screen against another one based on value, momentum, earnings quality, and predictibility and came up with a much smaller subset of candidates. Of the 8 remaining, I looked at specific financial ratios for each one and QLTI was the one that really stuck out as an anomaly. Keep in mind that Graham emphasizes having sufficient diversification among even stocks trading a 2/3 NCAV, so at least in theory, my just buying this stock should be just the first step among many others to follow.

As of the closing price today (April 13, 2009), QLTI is trading at $2.18, which represents 58% of its net current asset value. And, at least as of its balance sheet at the end of December 2008, QLTI has $4.40/share in cash. It has no debt and has been restructuring and divesting some of its products in order to focus on its core business of opthamological biopharmaceuticals. It recently paid out $2.50 a share for 20M shares in a tender offer at the end of January. Additionally, there has been plenty of insider buying taking place over the last few months. All of these factors made QLTI a particularly attractive stock.

In reading their 10-K, one thing jumped out immediately (which goes to show that you should always read a 10-K form). For US investors, QLTI is considered a passive foreign investment company or PFIC, which has significant negative tax consequences for US investors. Unless you’re willing to jump through hoops to invest in PFICs, you might be better off purchasing these in a tax-advantaged account like an IRA or Coverdell.

Are there other risks? Definitely, as there are with any stock you purchase, particularly ones in the microcap category like QLTI. The stock is trading at a discount for a reason, after all. In the case of QLTI, they have a limited number of products in their pipeline, many of which are only in Phase I of the FDA’s approval process. Their main competitor is behemoth Genentech, which has a few products that not only compete directly but dominate the market. These are just a few I can mention off the top of my head.

Unfortunately, since the time between the day I discovered QLTI (when it was trading at $1.80) and today’s purchase, the stock has gone up 20% already….which goes to show you how much time it takes to really look into a company (and even moreso when you’re trying to juggle a full-time job and a 9-month-old baby!)

Earnings are due to be released toward the end of April. We’ll see how this one plays out.

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