Model Portfolio teriksen:ESVF

Having written an article recommending GROW for purchase in the April Marketscope, I only think it appropriate to let others know that I have sold all my holdings of GROW. At the time I wrote the article the stock traded for $15 and was below my estimate of its fair value. It currently trades above $30 and is above my estimate of fair value.

My decision to sell is not all related to the industry. I continue to love asset managers when they are reasonably priced. What led me to sell my holdings, was GROW's focus on natural resources. Resource stocks have been falling and I tend to think they have further to go. The result has been weaker recent performance for GROW's funds and a flattening of their AUM (Assets under management).

My projections show that GROW should earn about $0.30 to $0.35 per share in a normal quarter assuming they do not earn any incentive fees from their hedge funds and management of Endeavour Capital. That results in annualized EPS of $1.20 to $1.40. Thus GROW is trading at 22 - 25 times earnings and not showing any recent AUM growth. That is too rich for me.

Some may argue that I should not ignore incentive fees and they would be right. But how to value them is quite difficult. They will only earn incentive fees when annual returns on their hedge funds are above 10% or above 8% for Endeavour. What is the realistic long term returns one should get in resource stocks. If it is not at least 10% then I would be correct in placing no value on it.

I think that is too conservative, but I also think the likelihood of them earning 35% returns like last year are not high either. Incentive fees only contributed about $0.45 after taxes and bonuses in fiscal 2006. If I assume that happens every three years, it only adds about $0.15 per year to earnings and still leaves the stock at over 20 times earnings when it has shown no growth for a few months.

All that said, I will continue to watch the stock carefully. I had previously sold a big portion in late May and early June after it rose quickly and precious metals starting declining. I repurchased again in August at about $20 thinking fair value was about $25 (I was unaware of the incentive fees bonus).

Hopefully it will fall again to a point where it is attractive.