New Position: Destiny Media Technologies, Inc. (DSNY.OB)

Today I picked up some shares in Destiny Media Technologies, Inc. DSNY.OB at $.40 per share on margin. I plan to pay off the margin loan next month, when I sell the wreckage of some of the stocks I bought from the Magic Formula Investing list last August. Destiny Media is a pick of "issambres839" on the Value Investors Club. Thanks to Daniel Wahl, I've learned that issambress839 is the professional value investor Aaron Edelheit, of Sabre Value Management in Santa Barbara, CA. Edelheit may be one of the best investors I had never heard of up until last month.

In contrast with many value investors who use trailing metrics such as P/S and P/E to screen for stocks (recall rules-based investor Marc Gerstein's frustration with this approach in "What's Wrong with Today's Value Investing?"), Edelheit often researches small stocks without current earnings that are nevertheless trading at a low multiple to his estimates of their future earnings. When he recommended DSNY.OB on the Value Investors Club in January (when it was trading at $.68 cents per share), Edelheit wrote that it was trading at 7x his estimate for fiscal '09 earnings (at the current quote, it's trading at about 4x his estimate; insiders have been buying on the way down). Destiny Media is the second stock I bought based mainly on Edelheit's write up (and subsequent news that confirmed his thesis); the first was the precision agriculture company Hemisphere GPS (HEM.TO), which I bought around $4.34 per share (Edelheit originally recommended it last summer when it was trading at $2.74 per share). Like Hemisphere, Destiny Media is a Canadian company. Edelheit is willing to consider obscure Canadian companies (including those such as DSNY that trade on the OTC Bulletin Board) in search of undiscovered values.

I recommend signing up for guest access to the Value Investors Club so you can read issambress839/Edelheit's write-up for Destiny Media in detail, but here's my summary in a nutshell. Destiny offers a service (its Play MPE network) that enables record labels to digitally (and securely) transfer songs to radio stations. The service includes security features such as a (recently patented) digital watermarking technology to prevent unauthorized redistribution of the songs. The value proposition here is that Destiny Media can save the record labels a lot of money: Destiny's service costs about 90% less than the old method of sending songs in CD format via courier. Destiny had been offering its service to some labels at no charge last year, but has been signing contracts with them to pay to continue the service this year. As Edelheit pointed out in his write-up, since Destiny's stock is obscure, foreign, and has no analyst coverage, few are aware of the paying customers it is lining up for its Play MPE network.

According to Edelheit, Destiny also offers a product called Clipstream, which is similar to Adobe Flash but uses 90% less bandwith. This product could a source of additional future earnings, but his multiple estimate above was based solely on Destiny's Play MPE service.

One note about risk: Destiny has a collection of conventional wisdom red flags for risk -- it's a microcap, it's foreign, and it trades on the OTC Bulletin Board. So it's not exactly a widows & orphans stock. Then again, in the last year we've seen stocks that some would have considered suitable for widows and orphans -- e.g., Citigroup, Fannie Mae, etc. -- suffer stomach-churning drops. This subject is a subject worthy of its own post, but the conventional wisdom about potential risk versus reward with respect to stocks may be worth revisiting.

"What's Wrong with Today's Value Investing?"

On Seeking Alpha, columnist Marc Gerstein asks, "What's Wrong with Today's Value Investing?"

That a veteran investor (see Gerstein's bio) would ask this question should give you a sense of how poorly many value strategies have performed recently.

Excerpt:

Remember the days when you could count on value investing as a solid defensive strategy? It worked that way as recently as the downturn we experienced earlier this decade. Lately, though, value has not been fulfilling this role. And there are reasons to wonder if this is more than a temporary oddity and whether the entire approach needs to be overhauled.

Later in his essay, Gerstein speculates on why value-oriented strategies may have under-performed recently:

This isn't the 1970s when the best source of market data for many investors was the monthly S&P Stock Guide (I'm not even sure they still exist). Back in the day, if a stock had such characteristics [low valuation metrics such as P/S, P/B, P/E, etc.], it could be because the investment community was neglectful. But in this day and age, with so much information so quickly and so widely available, it's likely that stocks have low valuation metrics because investors believe that's all the stock deserves.

It's a fair point that the wider availability of information today, via the Internet, may have made the stock market more efficient (thus making it harder to uncover mis-priced stocks¹), but certainly this was also true earlier in this decade, when (as Gerstein noted above) value strategies performed better. Gerstein is on firmer ground when he writes,

Success can't come from identifying cheap metrics. Anyone today can do that with a few mouse clicks. Instead, success comes from doing a better job in assessing company merit.

Since he is a "rules-based", or by-the-numbers investor, Gerstein addresses this by adding another metric to some basic value screens, this one based on revisions of analysts' earnings estimates for each company in his sample. This has the virtue of being a forward-looking metric, and one would think that securities analysts take into account macro trends when estimating future earnings. Gerstein mentions nothing about whether or how an individual investor ought to take into account relevant macro trends, or otherwise qualitatively asses companies' prospects -- this is beyond the scope of strict rules-based investing. There is no reason, of course, that an individual investor can't use a rules-based system (whether the Magic Formula, Gerstein's latest strategy, or any other mechanical screening system) to narrow down a universe of stocks into a smaller sample, and then use that sample as a starting point for further research.

¹"Mis-priced" in the sense that the market price of the stock is lower than the stock's intrinsic value.