Shuffle Master (SHFL): A Small Company Stock

SHFL makes automatic card shufflers and table games for the gambling industry (called “gaming” by some in the hopes of gaining respectability). I first looked at it in early 2005 when it was #6 out of 200 on the Forbes list of the best small company stocks in 2004. It ranked #20 in 2005 and has made the list for seven consecutive years.

In early 2005, it had high EPS growth rates that had declined to around 25+% for the last three years. Its Pre-Tax Profit Margin was high (33% average for the last 5 years) and trending up; its Return on Equity was also high (26%) and also trending up.

I took another look today when Value Line issued an updated report. The stock is covered in VL’s Small and Mid-Cap edition which means no estimate of a High Price in the next 3-5 years. That means I cannot judge the reasonableness of my estimated High Price by comparing it to VL’s. [I get the electronic version of VL from my nearby public library and don't even have to pay for printing.]

VL is currently estimating 25+% future EPS and the few other analysts that follow SHFL are also estimating around 25-27% future EPS. I usually reduce these estimates somewhat because I think they are often optimistic and sometimes over-optimistic.

When I projected 20.0% future EPS for the next 5 years and High/Low PEs based on Alt-M (24.6/11.5, the most conservative option built into the SSG software with the 5 highest values eliminated from the last last 10 years), the stock was way-far from a SSG Buy with a Risk/Reward or Upside/Downside ratio of .6 and a 7.6% per year Total Return compounded for the next 5 years. To buy any stock, the SSG criteria to satisfy are a 3.0 U/D, where the Upside reward is three times greater than the Downside risk AND a 15% per year compounded Total Return for the next 5 years.

When I used more liberal judgments, the average High/Low PEs from the last 5 years (which were much higher, 38.3/18.6) and tried them together with 20% future EPS, the stock still was not a SSG Buy. Only when I increased my EPS estimate to 25% did it satisfy both criteria.

PTPM has increased to 38.5%, which is super, but ROE has become meaningless: SHFL’s Book Value has substantially declined in the last two years (from $1.29 to 0.42 in 2004 and 0.39 in 2005) thereby artificially inflating its ROE since ROE = EPS / Book Value.

SHFL’s PE is sky-high and is selling at a significant premium or nearly four times more than its peers (103.95 vs 27.44) in the Hotel, Restaurant and Leisure industry according to Weiss Ratings. However, Reuters.com places SHFL in the smaller Casino and Gaming industry where SHFL’s PE is almost three times higher than its peers (95.70 vs 34.89). And, MSNMoney considers SHFL to be in the Diversified Machinery industry with a PE that is five times higher than its peers (98.10 vs 17.80).

I’m not interested in this stock because its PE is astronomical, my assessment depended too much on using high estimates, SHFL’s recent Book Value and resulting ROE make me uneasy, and my sense is that the so-called “gaming industry” is erratic and faddish.

- What do you think?

armin