I received an email earlier today from a reader suggesting a micro-cap value company, Eternal Technologies, Inc. (ETLT.OB). Operating in China and incorporated in Nevada, the company offers embryo-transfer services, large-scale improvement of livestock quality, and the development of agricultural and medical  products. If you know exactly what any of that means, shoot me an email. I’d love to know.

But all joking aside, the company seems compelling due to its attractive valuation.  Its price to tangible book value, coupled with boatloads of marketable securities and cash on hand, give the company around a 40-50% discount to realizable asset value. All the while, the company has virtually no debt, a profitable income statement, and is cash flow positive. It also expects much of the same in the coming year(s).  So with all that going for the stock, it’s a no-brainer, right?

Not so quick. Before getting too giddy about the opportunity, I wanted to share my email response to the suggestion. Forgive me again for allowing my cynical side to run amuck, but I believe their are several risk factors in the company that are tempering my greedy side. Here goes:

“I’ve checked out ETLT before and went back to take another look. The cash in the bank is tempting, but I’m a bit    hesitant to buy any shares. I see the company as having several material risks offsetting its net asset value.

First, the company is a Chinese operation with ‘government backing.’ Truth be told, I have no idea what that means, and, for that matter, I don’t know if I like the Chinese government backing anything I have my money in right now. I know little to nothing about China, and I believe investors face substantial risks investing there, and should be prepared to heavily discount any investments there.

Second, the company may have that cash stash, and you may be right that their acquisitions are good. But I just don’t have the ability to say one way or another. And generally speaking, when I can’t tell for sure that an acquistion is good, I assume it’s bad. That said, I’d love to see [more of] your research on this.

Third, the business is inherently complex, and given the high tech area in which it operates, I have no special knowledge that can give me an edge. Tell me that management planned to distribute what they have in the bank or allow it to earn returns in a much simpler business then that’s a different story. I have no idea what they plan to do with the assets, and because they’re investing in (other) high tech businesses, I’m especially afraid that whatever they do, it’ll be stupid.

Fourth, be careful not to fall into the trap of looking at the total asset value and not the diluted per share values. The company has been issuing equity at a rapid pace, and has 2.5 million shares worth of in-the-money options waiting to be exercised. Running a quick calculation reveals a ‘true’ per share value of about $1.11 in book, not $1.30.

And last but not least, I always worry about these very small operations having materially significant deficiencies in accounting and control procedures. Though their auditors (whom I’ve never heard of) issued a clean opinion, they also reported at least two material deficiencies [in the past few years, including 2005]. And, on a completely different note, their somewhat sketchy website doesn’t ease my worries. I’m not saying they’re fraudulent, but you never know what ugly practices lurk behind the scenes.

Again, I’d love to see or hear more research. If my aforementioned fears could be eased, I’d be very interested in purchasing shares…”

I’ve seen a fair bit of bullishness on the stock on message boards, other posts, etc. The enthusiasm is understandable. Give any investor a profitable and growing company trading for less than liquid assets, and they well should be excited. But I believe ETLT is a different can of worms, with a set of unique risk factors that must be taken into account and fully realized before any investment is made.

Note: If you haven’t already deduced from above, I do not own shares in ETLT.OB.

I’ll be publishing something cliche to the extent of “Where to Look in 2007″ within the next few days, but don’t expect anything too special. I don’t like touting stocks when I don’t have very many good ideas (and trust me, I may have a few, but not many), and I’ll probably focus more on areas to look rather than specific stocks.

That said, I’m always on the hunt for bargains and ideas, and I research ideas every day. So I’ll continue writing as much quality content on specific companies as I can, but I want to be sure to give them fully deserved attention. Fair warning

See you soon.

Given the oustanding quality of readers’ analysis and comments I’ve received on the site and through email, I’ve added a Submit an Idea page to promote more of a community atmosphere. I always love to hear your ideas and research, and I’m happy to publish articles of high quality content and top-notch insight (with a link to your site, of course). Feel free to submit anything you’d like me to take a look at. Looking forward to hearing from you…

It’s hardly a problem when it comes to sex, but it’s a big problem when it comes to investing. What, was that too forward?

Okay, fine. I apologize. But seriously…

When investing, it’s easy to become caught up in hype and activity surrounding the stock market. We have a natural tendency to want to just do something when everybody else is doing something. Red and green tickers flashing every few seconds, streaming news stories, hyper-active Wall Street types screaming their buy orders, and a host of other signals all tell us, often without our conscious awareness, that we are being left behind and that, to keep up, we must partake in the festivities. After all, who wants to miss that quick buck promise from a screaming Jim Cramer? And who wants to sit idly while someone (on TV, nonetheless!) tells them their favorite stock is a dud?

So what’s the problem with this? Well, to put it in plain English, intelligent investing often requires you to sit quietly on your ass. Active trading does several harms to your portfolio.

First, it fails more often than not. Those who believe they know where a stock is headed in the next day, week, or month often have no clue and are merely speculating. Second, it takes away valuable time for thorough research. Time spent sitting and staring at your tickers does nothing to give you great ideas, presents an opportunity cost since you could be reading a 10-K and getting to understand a company instead, and often results in anxiety because you’re so damn worried what the stock will do next. But who cares? If you’re right about it, it’ll go up eventually. Give it time and leave it the hell alone. Third, active trading increases transactions costs. Granted that with extremely low online commission expenses one trade is not that big of a deal, but if you’ve actively traded for an entire year, you’re looking at hundreds, if not thousands, of dollars in excess commissions by year’s end. For most people with portfolios of a small size, this can represent a large percentage of the portfolio. And finally, it ups the value of taxes you have to pay. With short-term capital gains taxed at income levels, trading gives you an extra hoop to jump through in order to beat the market.

How is one to deal with over-stimulation? I, for one, force myself not to look at my portfolio more than once a day (if that), and I never keep any sort of streaming quotes on my computer screen. I avoid reading anything having to do with a short-term trading idea (some say this is ignorant. If so, I say ignorance is bliss. And lucrative). I limit the amount of time per day I spend syphoning through blog posts, message boards, or any other potentially stimulating activities that don’t give much in the way of researched ideas or sound advice (do me a favor and please tell me if my own blog diverges from this). Finally, every time I’m tempted to check quotes or start buying and selling things on a whim, I walk away, take a break, come back and read a 10-K instead.

Conquering the desire to stay active and do something is no easy task. It often requires boring substitutes like reading SEC filings. But I believe avoiding the devastating tendency and conquering over-stimulation is necessary for prolonged success. After all, some things are better saved for the bedroom.

USG has gotten a fair deal of press given Warren Buffett’s holding in the company and its emergence from Chapter 11 Reorganization to handle its asbestos liability claims. Plenty of folks are calling it a bargain, and some are itching to keep buying, but to temper myself I took a more in depth look at the company to get a feel for what it’s worth.

First things first. In summary fashion, the plan of reorganization and the company’s own plan to finance it are as follows: The company has paid $3.95 billion to a trust established under section 524(g) of the Bankruptcy Code which will be used to fund all past, present, and future asbestos liabilities. With over 100,000 cases previously brought against the company, at least they won’t have to bother with them again.

The company is financing this large sum with a combination of available cash, the use of an approximately $1.1 billion tax loss carryback expected in 2007 thanks to net operating losses incurred in connection with establishing the original asbestos reserve, and proceeds from a “Rights Offering,” in which shareholders had the right to purchase an additional share at $40 for each share they owned. With Berkshire Hathaway backstopping the offering, almost 45 million shares were sold, for net proceeds to the company of $1.7 billion. Despite the dilutive effect of the rights offering, I believe this combination was an intelligent way to finance the nearly $4 billion liability (of course, it helps that $1.1 billion of the liability is going to be financed by benefits received from the original loss incurred by it).

With this success and Buffett’s purchase and commendation of the company, it’s no wonder many are tempted. So now let’s look at the operating business, independent of the now bygone liabilities. USG is the top producer of gypsum wallboards and boasts a strong brand image (ever heard of Sheetrock?), low-cost producer status, and great economies of scale. It’s qualitative moat, if you will, rests on the fact that anyone, even with tremendous resources, will have difficulty achieving the scale, distribution, and cost structure of USG’s main product lines, and will probably have a tough time replacing Sheetrock’s brand image. Given management’s experience and its top-notch performance in bankruptcy court, you can rest assured that the company is in good hands.

Regular operations (prior to distored earnings from last year) sport a high return on equity and strong cash flows. The company has been successful in expanding its top and bottom lines over the long term. While plenty of pundits predict slowdowns in the residential property sectors and hence USG’s sales, the company draws over half of its revenues from commercial buyers. And regardless, the long-term, big picture is more important than trying to predict the next swing in the housing market. So, what about the valuation.

Before getting too giddy about Buffett’s buying, investors should consider 1) that he originally purchased shares at bargain basement prices in 2001 and 2) that his recent accumulation of shares was done at $40-45 (as opposed to the current $55 pricetag). Also, keep in mind that his costs were partially offset by USG’s $67 million fee to Berkshire Hathaway for backstopping the rights offering. Thus, enthusiasm tempered, we can try to look at a DCF.

Generally speaking, I don’t like quoting anything near precise figures for any DCF, since the output is only as good as the inputs, and because if the analysis doesn’t scream at me as giving a huge margin of safety, I’m not too interested anyway. That said, I estimate the value of the shares to be somewhere between $50 on the low end and $85 on the high end. I know, I know, that’s a wide discrepancy, but like I said, I think seeking a high degree of safety (a margin of error) is paramount to seeking a high degree of precision. Considering the limited downside and potential 60%+ upside, investors looking to coat-tail Mr. Buffett may still do reasonably well in USG, though no one should expect many-fold increases with high probability (though I’m the first to admit it is possible).

I wrote about LENS two weeks ago in a post briefly discussing my basic thesis on the stock. To briefly sum up the general idea, LENS, despite the terrible economics of its core business (single-use cameras), LENS is sitting on a boatload of cash and saleable assets while trading for just a fraction of its tangible net worth. Today, I would like to more fully discuss catalysts behind the stock’s recent run-up, and potential future catalysts for reaching what I believe to be an intrinsic value still plenty higher than the current share price.

The stock has nearly doubled in the past two months, largely thanks to 1) a reduced quarterly cash burn and increased earnings thanks to heavy cost cutting measures and 2) extraordinarily heavy insider buying by the company’s CEO, Ira Lampert (which has constituted a tremendous chunk of volume in the last two weeks). Lampert has accumulated an additional 4.24% of the company since mid-November at prices between $3 and $4.60 per share, bringing his total ownership around 8.4%. The transactions have been largely open market, with one recent 75,000 share purchase via exercisable options.

In any case, it’s clear to me that Lampert is either a) very bullish about the prospects of profitability going forward (I’m not), b) accumulating as many shares as possible at low prices before planning to commence some sort of buyout or larger tender offer, or c) crazy. A few would argue c), more would hope for b), and I speculate that it’s a), due somewhat to my tendency to be pessimistic and cynical. Which presents a problem, of course, since I don’t think the company will reach sustainable long-term profitability anytime soon, and, possibly ever (yes, I said it).

Despite having a large chunk of the single-use camera market, the market is shrinking quickly and will likely not exist ten years down the road. Disposable cameras are dinosaurs in the “image capture market,” analogous to the horse and buggy during the early parts of the 20th century. So don’t hope for miracles in this department.

The company is aware of this, and is attempting to enter other markets via the manufacture and marketing of, for instance, personal security equipment (check out their OnGuard Kids site). My guess is that they believe their current manufacturing infrastructure can be relatively easily diverted into making new widgets like these watches, while their solid relationship with Walmart can be leveraged to get these things on the shelves. This would mean low entry costs with safe demand, opening up new sources of revenue for the company. But here’s the problem with that as an investor.

Regardless of the optimism that one could easily get caught up in, investing on the basis that entirely new products will drive future growth is inherently entrepreneurial. As an entrepreneur, there’s nothing wrong with that. But as a value investor, there is. So allow me to do two things. First, the entrepreneur in me will evaluate OnGuard Kids as a new or “innovative” product (hint: it’s not), and second, the value investor in me will talk about the [better] reasons for investing.

The Entrepreneur: I just don’t think it’s a very great product. And if you disagree, I don’t think these things would ever sell to more than the overly paranoid soccer mom market. Here’s my take in short. The product is simply a watch with a loud alarm on it to warn others of danger or ward off kidnappers. That’s it. Nothing fancy. The problem with that as an innovation is that, well, it’s not an innovation. Better such watches exist, and new devices with GPS tracking power (which OnGuard does NOT have) have and will continue to hit the market (for instance, check out here). Furthermore, the market for a second-rate product in a small demographic (overly paranoid soccer mom market) just isn’t that big. And for a second-rate and cheap-looking product, the watch is expensive ($40). As with single-use cameras, don’t count on miracles. If Wal-Mart is dumb enough to stock it, don’t expect much demand from the end-customer.

The Value Investor: The company can manufacture all the new widgets it wants. None of this matters all that much because LENS is, to me, an asset play! The company is conservatively worth around $7.80 per share and likely more, given its stash of cash, reduced cash burn, and “safe” liabliities. An investor should be investing on the basis of the margin of safety and the low probability that management depletes the boatload, and NOT on the promise of entrepreneurial riches (though I do hope the company will prove me wrong). While a successful new venture leading to profitability will send the shares skyrocketing, I wouldn’t count on it with any high degree of certainty. Yes, profitability seems to be on the horizon with the reduced burn. Yes, management at least recognizes that it is selling buggies to Ferrari drivers. And yes, profitability would be especially bountiful with $16.7 million of US and $54 million of foreign (mostly Hong Kong) tax-loss carryforwards expiring in 2010 and 2016. But that is all wishful thinking.

Luckily, the company has a plethora of other catalysts to make the risk/reward ratio quite low. A 50% margin of safety, heavy insider buying, a possible buyout for that matter, very little debt, the exitting of unprofitable business lines, etc. The main risk factor is that management does something stupid with its balance sheet and pursues highly unprofitable lines of business. But given how conscious they have become about costs, this seems unlikely, and I am betting that they maintain at least the present asset base. This would allow the shares to more than double (again).

Soccer moms and Wal-Mart aside, there is an unmistakable “venture-like” element here, but like a good value investor, it’s the stodginess and cash that courts me.

Note: I own shares in LENS. I do not own shares in WMT.