UndervaluedSecurities.com Total Return Fund (Virtual Fund)  is launched TODAY, Wed, May 21, 2008 with initial virtual capital of $100,000. Positions may change at any time.

Today, we initiated new long positions in 5 companies that we believe to be undervalued. Here are our initial positions: Berkshire Hathaway (BRK.B), Starbucks (SBUX), RenaissanceRe Holdings Ltd. (RNR), Endurance Specialty Holdings Ltd. (ENH), and Yahoo (YHOO). For detail portfolio, click the top menu link or lef menu link titled "Portfolio" or click here.

Berkshire Hathaway (BRK.A and BRK.B. We invested in BRK.B) has been depressed lately due to poor earning release and also declining value in several of its investment holding (e.g. Moody's comes into mind). However, Berkshire Hathaway's balance sheet and cash flow are stellar and growing. We believe Warren Buffett, 77, is savvy businessman/investor that will keep expanding his business operations and investments in areas that will benefit his long-term oriented shareholders. Buffett is now travelling to Europe to woo family businesses to sell their companies to Berkshire Hathaway.  He is tireless and focus on expanding his shareholders wealth (it doesn't hurt that he and Charlie Munger, his sidekick, has 99% of their net-worth in Berkshire Hathaway). Our target price for BRK.B: $5,500 / share by end of 2008.

Starbucks (SBUX) is now depressed due to reduced sales per store basis and market saturation in the US. However, the shining light is in its international growth and profitability. SBUX has strong fundamentals with average free cash flow of around $400-500 million per year that most likely will grow in the future due to its international growth. Howard Schultz, Starbucks Chairman & CEO (yes, he has been back since Jan 2008; this is a good sign for shareholders as he owns tons of SBUX shares) passionately stated in Jan 2008 annual shareholder letter that he would focus on Starbucks international expansion and most importantly, rebuilding Starbucks brand loyalty in the US and globally. We believe his passion in addition to SBUX strong brand name and fundamentals. Our target price: $25 / share by end of 2008.

RenaissanceRe Holdings Ltd. (RNR) and Endurance Specialty Holdings Ltd. (ENH) are both in reinsurance business which carries lots of long-term risk but could be very profitable for prudent reinsurance companies that focus on sound risk management and building long-term shareholders value. We believe both RNR and ENH fit the bills. Both are run by shareholders-friendly management that are the best-in-class in the industry. Both use debt sparingly and have strong balance sheet and cash flow streams. Yet, both are depressed due to what we believe as incorrect perception of reinsurance businesses; and yes, they both provide decent dividends at current market valuation!Our target price for RNR: $75 / share by end of 2008. Our target price for ENH: $55 / share by end of 2008.

Yahoo (YHOO) is interesting company. Despite all the focus on Microsoft and Yahoo deal, people mostly have overlooked that Yahoo is still a profitable and growing online media company that owns big stakes in various Asia Pacific's biggest most promising internet companies like Alibaba and GMarket. YHOO has its flaws and weaknesses especially in its search engine and ads engine. But overall, YHOO is still a better value than Google (GOOG); and there are many interested parties (especially the hedge fund managers like Carl Icahn, Paulson, Boone Pickens) who are pushing the deal between MSFT and YHOO to continue. The only reason they bought YHOO shares is because they all believe that YHOO stock prices could go up much higher than the current price and also ride the possibility that MSFT might come back with a deal later. In our opinion, deal or no deal, YHOO is strong fundamentally; and we also like the fact that YHOO is now run by its co-founder, Jerry Yang. Usually, a technology company is better off in the long-run being managed by the founders who have tons of stakes in their own companies rather than by highly-paid hired guns. Our target price: $35 / share by end of 2008.

Obagi (OMPI) is an undervalued small cap that operates in skin care area (note: ladies, pay attention!). Here is brief description of the company (from Yahoo Finance):

Obagi Medical Products, Inc., a specialty pharmaceutical company, develops and markets skincare products in the United States and internationally. It develops and commercializes prescription-based, topical skin health systems, which enable physicians to treat a range of skin conditions, including pre-mature aging, photo-damage, hyper-pigmentation, and acne, as well as soft tissue deficits, such as fine lines and wrinkles. 

We like the facts that Obagi has significant insider/management ownerships (37%!), strong fundamentals (debt free with cash and cash equivalents totaling $21.3 million), strong existing & new product lines and is very profitable (Gross Margin > 80%, Return on Equity >40%, Operating Margin > 25%), growing, and yet sellling at depressed valuation due to current slowing economic condition. However, reading the recent financial report, Obagi is still growing nicely and profitably:

"For the first quarter of 2008, net sales rose $2.3 million, or 10%, to $25.4 million, compared with $23.0 million in the first quarter of 2007. The 2008 first quarter showed strong growth in the ELASTIderm™ product line, which contributed $4.6 million in net sales, compared to $2.3 million in the immediately preceding quarter. The sales for the ELASTIderm product line was the result of a positive reception to Obagi’s new ELASTIderm Décolletage System, which was introduced in late January 2008.

Gross margin percentage was 81.4% in the first quarter of 2008, compared with 82.8% in the same quarter last year, and compared with 81.9% in the immediately preceding quarter. The slightly lower gross margin was primarily due to incentives related to the launch of ELASTIderm Décolletage and product mix."

The company generated  free cash flow (FCF) of approx. $12 million last year and most likely this figure will grow safely at average rate of 15% annually for the next  5 years (note: analysts on average projected 22% annual growth rate for the next 5 years which in our opinion, too aggressive). Applying P/FCF of 15 times for a company of this caliber, resulted in $180 million valuation not counting the book value. If the company keeps growing nicely, in 2013, it could generate approx.$30 millions of free cash flow at that time and could fetch a market cap of around $450 million at minimum (2.5 times current market valuation). Our target price: $10 / share by end of 2008.

Stay tune for updates on UndervaluedSecurities.com Total Return Fund (Virtual Fund)!

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