Continuing To Hold Hawkins, Inc.

Since I added to my position in Hawkins, Inc. (NASDAQ:HWKN) a little over five months ago, the shares are up about 8.1% against a gain of about 3.25% for the S&P 500. While this is gratifying on some level because it gives me the opportunity to engage in yet more nausea-inducing bragging, it puts me on the horns of a dilemma. A stock trading for $40.50 is a much more risky investment than the same stock when it's trading at $37.60, so I must review it again. Since the company has reported financials since, I'll review those to see if my thesis remains intact. Additionally, I'll compare those results with the valuation to see if the market is reasonable with its expectations here.

My regulars may be getting ready to cringe fairly hard at the moment, because they know that when I outperform the market with one of my investments, I'm inclined to subtly, and not so subtly bring up that fact repeatedly. I'm typical of contributors in this way, but I'm atypical in my tendency to make a "thing" about it. Anyway, in case you're not in the mood for my incessant bragging, I offer you a thesis statement paragraph where I give you the gist of my thinking upfront, so you can learn what I'm doing and why, and then get out before getting too much "Doyle self-congratulatory mojo" all over yourself. You're welcome. I think the most recent financial performance here has been great, and I welcome the uptick in the dividend. The addition of new debt is troublesome, but, per the latest 10-K, there are no significant cash obligations due for at least another five years. By some measures, the shares are cheaper than they were, but I think the assumptions embedded in the current price are a bit too rosy for my taste. That, plus the fact that the dividend yield is below the risk-free rate by a wide margin doesn't fill me with a strong desire to add to my stake. While I'm not going to sell, because I expect great things from the business in the future, my desire to preserve capital prevents me from adding aggressively at the moment. This ends my "thesis statement" paragraph. If you read on from here, that's on you. I don't want to read any bellyaching in the comments section below about the fact that I highlight my successes too aggressively, or that I spell words like "colour" and "flavour" properly.

Financial Snapshot

The financial results here have been spectacular in my estimation. Relative to the same period a year ago, revenue and net income are higher by 28% and 18% respectively. Costs increased across the board, notably cost of sales increased by 31% or $136 million, but these increases weren't enough to dampen the $155.4 million uptick in sales relative to the same period a year ago. Management rewarded shareholders for this performance with a higher dividend in 2022, which was up by 9.8% compared to 2021. Additionally, the company has just announced yet another dividend increase. There's always a risk that the year you're comparing to was terrible, so comparisons to that year are going to look overly rosy. If that's a fear in this case, fret no further. The most recent financial results were exceptionally good when compared to the pre-pandemic era also. Revenue and net income were higher by 73% and 105% respectively. There's no other way to put it but that the latest results were excellent.

It's not all sunshine and lollipops, though. Debt is higher and cash resources are down by about 74% relative to the same period in 2021. Although I'm bothered by the $2.9 million (287%) uptick in interest payments, and the fact that indebtedness is up by $14.8 million, or 12.8%, I'm not too worried about the sustainability of the dividend. This is because there are no large demands on cash until 2028 at the earliest, per the following pulled from page 20 of the latest 10-K for your enjoyment and edification.

Given all of this, I'd be happy to buy more of this stock at the right price.

The Stock

Those of you who read my stuff regularly for some reason know that I have talked myself out of some great investments with the phrase "at the right price." As a starting position, I'm not willing to overpay for an investment, because what the market giveth, the market eventually taketh awayeth. So just because a company like Hawkins is growing well, that's not enough in my view. This is because "companies" and "stocks" are different things. It's also time for me to be a total "buzzkill", as the young people say, because I remind investors that a great, solidly profitable company like this one, can be a terrible investment at the wrong price.

Taking the first point first, the business generates revenue and profits, and the stock is a speculative instrument that gets traded around based on long-term expectations about the business. Given that the financial statement valuation of the business is "backward-looking" and the stock is a forecast about the distant future, there's an inevitable tension between the two. The tension is highlighted by the fact that the business is about selling specialty chemicals, for example. The stock, on the other hand, is a piece of virtual paper that is traded around, buffeted by a host of factors having little or nothing to do with the underlying business. One of the things that affects the performance of a given stock, for example, is the crowd's ever-changing views about the desirability of "stocks" as an asset class. There's no way to prove this definitively, as it's an obvious counterfactual, but a reasonable argument could be made to suggest that my performance on this investment was boosted to some degree by the (admittedly smaller) market return since then.

So this is why I consider the stock as a thing distinct from the business. The former is often a poor proxy for what's going on at the company, and I think it's possible to profitably exploit this disconnect. In my view, the only way to successfully trade stocks is to spot the discrepancies between what the crowd is assuming about a given company and subsequent results. What I want to see in this regard is a stock that the crowd is somewhat pessimistic about that goes on to exceed expectations. When the crowd is pessimistic, the shares are cheap, which is why I try to buy only cheap stocks.

In my previous piece, in case you don't have your copy of my latest trades in front of you, I got excited about this company because the shares were trading at a price to sales ratio of about 0.96, a PE of 14.8, and I was reasonably happy with the dividend yield of 1.44%. Fast-forward to the present, and the shares are actually slightly cheaper, though the yield is slightly lower per the following:

My regulars know that I think ratios can be instructive, but I also want to try to work out what the market is "thinking" about a given investment. If you read my stuff regularly, you know that the way I do this is by turning to the work of Professor Stephen Penman and his book "Accounting for Value" for this. In this book, Penman walks investors through how they can apply some pretty basic math to a standard finance formula in order to work out what the market is "thinking" about a given company's future growth. This involves isolating the "g" (growth) variable in this formula. In case you find Penman's writing a bit opaque, you might want to try "Expectations Investing" by Mauboussin and Rappaport. These two have also introduced the idea of using the stock price itself as a source of information, and we can infer what the market is currently "expecting" about the future. Applying this approach to Hawkins at the moment suggests the market is assuming that this company will grow earnings at a rate of only ~6.5% in perpetuity. I consider that to be a pretty optimistic forecast for any company.

Given that I'm in the mood to preserve capital, and given that the current, admittedly well-covered, yield sits about 273 basis points below the risk-free rate, I'll not add to my position today. I'm not going to sell, because I really like this company, but I'm not putting more capital to work here at current prices.