To understand how a company operates much knowledge is needed. One thing that is needed in particular is the understanding that a company keeps three separate books on record but only one of them you, as the investor, generally has access to. 1) the company’s books for the purpose of shareholder reporting – 2) the tax books of the company which are completely different than what the company reports in the Income Statement – and 3) the reconciled company books that reconcile the shareholder books and the tax books that only the company has access to.

If you are a 1% owner of a company, you have the right to ask the company and receive from the company their tax books. This situation wouldn’t and doesn’t apply to most average investors. However, no one can get a hold of the ‘actual’ company books which reconcile the two sets of books.

As an investor, you need to read everything concerning the company that is available from the SEC filings. Most of today’s investors make the unfortunately mistake of receiving the majority of their information from investment blogs and financial sites such as google and yahoo. Unfortunately, often times that information is incorrect and that’s no exception in the case of Asta Funding. I’ve rarely seen sites such as yahoo or google correctly categorize or use the correct data on their sites. In order to minimize your downside risk, any investor that wants to make rational, logical, and intuitive decisions regarding their capital MUST have the correct information to draw their conclusions from. You can bypass much agony by using information accessed ONLY from the SEC.

Although the average investor doesn’t have access to the company’s “actual” books and tax books, he can find this information with a bit of effort because that information is available to him within the quarterly and annual reports. Most often, however, the average investor is unaware of this for various reasons. An investor must know what a deferred tax assets or liability is and how it affects the purposes of shareholder book reporting versus the “actual” books of the company. An investor must recognize that there is a “timing” difference between what is reported for book purposes and what is reported for “actual” cash tax purposes. The investor should recognize that, in the case of a deferred tax asset, the asset can be and often is carried forward (loss carry forward) for shareholder book purposes which often benefit earnings – but the “actual” books are accelerated. This, most often, is a drastic difference from what is reportable to the shareholder for book purposes and what is “actual”.

With these types of knowledge, and many more I haven’t talked about, the intuitive investor can make sound choices regarding the future operations of a business. This is the meaning of working within your circle of competence. Understanding is competence, not whether you know the management of the operation on a personal grounds.

Asta Funding reported several months ago a worst case scenario. In their example, the worst case scenario was that a large portion of their receivables value became noncollectable and that they would have to relinquish the ownership of that particular portfolio back to the bank that provided the company with the leverage to initially purchase those particular receivables. In the process of doing so, Asta would benefit by receiving a tax refund in the neighborhood of $30 Million.

For 2009, Asta reported that the worst case scenario had come to fruition. On their books for the shareholder, they listed a $56.79 Million tax provision of which they plan to receive approximately $46 Million in the form of a tax refund sometime during 2010. Prior to this in 2008, the company listed a deferred tax asset of $15.57 Million. A deferred tax asset is reported on a particular year but recognized the following. That is why they are apart of the “current asset” structure of the balance sheet. Anything current means within one year, conversely, anything long term means longer than one year. They reported the deferment in 2008 which will be used for 2009.

Going back to 2009, we can see the role that the prior years $15.57 Million deferred tax asset played in the 2009 provision for income taxes but before we do so, we need to recognize the increase in deferred taxes that occurred between 2009 and the previous year that impacts the  earnings and is a component to the 2009 tax provision.

In the footnotes of the company’s filings (F-24), you will find the components of deferred Federal and State taxes. The company recognized for shareholder book purposes (again, much different than actual) an additional deferred tax of $8.5 Million. This amount is apart of the provision for income taxes.

Therefore, if you subtract $8.5 Million from the total $56.79 Million 2009 tax provision, the result is $48.29 Million. It’s important to note that the company wrote off $8.45 Million in Interest Expense which shielded the company from taxes but actually paid $9.08 Million according to the statement of Cash Flows. difference of $630,000. Deducting that difference from the the $48.29 Million we come to $47.66 Million. If you’ll turn to the Balance Sheet for 2009 and notice the item “Prepaid and Income Taxes Receivable” you’ll see nearly the identical number that I’ve just presented of $47.73 Million; with the exception that I’m using whole numbers in my calculation for simplicity’s sake and is the reason for the very small discrepancy as well as not including a very small item within the provision of a few hundred thousand dollars that makes very little difference in our analysis here.

So far, we’ve seen how the current increase in deferred tax and interest expense played apart of the tax provision. Continuing,  back to the prior year’s deferred tax asset of $15.57 Million. This, being reported in 2008, is recognized in 2009 and we find that by deducting $15.57 Million from $47.66 the resulting number is $32.09 Million. Identical to the “worst case scenario” amount that was mentioned by the company. These are the components of the 2009 tax provision.

One very important part regarding the Balance Sheet that must be recognized and mentioned here is that the “prepaid income tax receivable” of $47.73 Million that is recognized for “book” purposes will completely disappear when the company realizes this value in the form of a tax refund in 2010 (according to their expectations when they’ll receive the refund). Therefore, the book value of the firm will decrease AT LEAST by $47.73 Million. Currently, the “stated” book value of the company is $160.20 Million or $10.96 per share. Deducting $47.73 from that tells us the TRUE “stated” book value of the company which is $112.47 Million or $7.70 per share. A very large difference and the “actual” situation being even more bleak than what I am presenting.

Looking forward now. One thing of particular importance to understand regarding Asta is that, in the past, Asta has never been a cyclical type of business. Meaning, they have never increased revenue’s due to special events such as Holiday shopping or special bargain sales events. Their revenue stream has always been relative quarter to quarter with very few exceptions. This has been true up until recent times in which their generation of revenue has declined dramatically due to a number of reasons that I won’t elaborate on here.

Therefore, taking one quarter of earnings and multiplying it by the four quarters involved in an annual business cycle will produce a reasonable bit of information that carries a high probability factor. This currently works out to $8.5 Million for the entire 2010 year. As we see in our past example regarding the deferred tax asset, in 2009, Asta reports a tax deferred asset of $24.32 Million which will be recognized in 2010; 2.86 times larger than what the company is currently on track to producing without it. In the most recent company filings, Asta reports that they expect to produce a net income between $30 – $35 Million for 2010.

Looking at our past example, its fairly easy to find out how they will do that. If we estimate, based off of the current information we have, that Asta will produce $8.5 Million in Net Income from operations and add to that the previous years tax deferment that will be recognized in 2010, we find that $8.5 Million + $24.32 Million = $32.82 Million; EXACTLY matching what the company stated in their last conference call.

This is, and should be for you, a very large concern of how Asta is operating. Although Asta, for tax purposes, accelerated the impairment recognition, for book purposes they are allowed to “loss carry forward” on these items which, as you will see in the very near future, will falsely give the impression that Net Income will increase in 2010 from 2009 and the previous year.

The truth is that Asta is benefiting currently from their impairment loss carry forwards and there will come a point in time where that benefit they are receiving in the form of tax refunds and deferments will cease and the company will have to rely solely on their ability to operate their business. Thus far, and especially looking forward to 2010, the company is in dire straits because revenue has decreased to the point that 2/3 rds of their Net Income is coming by way of Taxes.

It is important to note that, as of the first quarter of 2010, Asta did not recognize any additional impairment charges. Therefore, it is certain that the tax deferred assets will no longer exist to the same degree it has in the recent past. The only exception to this would be if additional impairment charges are taken against the receivables of the business in the future. By doing so, greatly diminishes the asset value of the firm and drastically decreases earnings in future years.

So, what I see happening is that the company will report somewhere in the neighborhood of $32 – $33 Million in revenue which will reflect a $2.25 EPS for 2010. The company has historically traded at 9 times earnings which would place a market price on Asta of $20 per share. This is a very high estimate. I believe the average investor will look at shareholder reported earnings, get excited, and overvalue this business somewhere between $15 – $20 per share. But a discerning investor will see the huge discrepancies I’ve listed and realize the fact that without the governments help, this company’s actual earnings from their operations is only approximately $0.60 per share which would give a $5 per share market price.

If the company continues to operate, as I’ve listed above, it would be wise for an intuitive investor to recognize the profit potential of shorting this company if it trades where I believe it will at the end of 2010 into 2011.

For the record, I sold my position a few weeks ago and ended up making an approximate 44% annual return. I sold because it was the time to sell and it has allowed me to sit back and observe, think, and rationalize my next move in this opportunity.

Adding insult to injure, at the same time as all of this – the company has hired past managers of the company as consultants in which the company pays them more in consulting fee’s than what their annual salaries were when they had an active management role in the company. The company has taken direct loans from an entity owned by members of the Stern family (controlling owners and managers of Asta) at a rate of 10% per year during a time when banks are lending at an all time low (Fed rate was less than 1% for the majority of 2009). Company managers have received large stock option bonuses in addition to their regular salary and have exercised those options during the recession; all of this while largely decreasing its ability to generate operational income.

After having knowledge of this information an important question needs to be asked. Does this seem like the type of company who puts the shareholder first? I’ll leave you to answer that for yourselves as each of you will have varying answers.

[Disclosure: This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

Part 1

Video

Part 1

Part 2

Here’s the Chart (click to enlarge)

Here is a 10-year look at the Wilshire 5000 Index as a percentage of total GNP (Not GDP that many erroneously use – big difference). Warren stated in the above article: “For me, the message of that chart is this: If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200%–as it did in 1999 and a part of 2000–you are playing with fire. As you can see, the ratio was recently 133%.“

I start this chart where Warren left off at the 133% ratio. If someone using this chart as a reference (I don’t advocate using charts for your stock picking metrics and don’t worry, I’m not turning into a chartist), that person using a Margin of Safety could have placed some very nice bets starting in January of 2009 such as many value investors did.

[I will expand on this in the near future to backdate the ratio to previous years when I have finished collecting all the relevant data.]

Irrational:

Rational: