AVX Corporation (NYSE: AVX) makes electrical components of all kinds. These parts regulate, filter, and store electrical energy. Essentially, they are the hidden infrastructure inside nearly every electronic device—the crucial components behind cell phones, radios, computers, and much more. Any- thing that needs electrical components could be a potential user of AVX’s broad and diverse product line, which covers over 100,000 product types.

For example, AVX makes 90 percent of the components found in a laptop computer (which has over 1,800 components). It also provides 85 percent of the parts used in a typical cell phone (which has over 500 parts). Just think of all the electronics used by a modern automobile—AVX makes components for those, too. The range of AVX products and applications is staggering.

And with new services and innovations driving the demand for electronic parts, there is no end in sight to the growing number and complexity of these components.

In terms of increasing complexity, just look at the circuit board of the original Intel Pentium processor. That chip had 252 components. Today’s Pentium uses over 900 components. Let me give you another example: Electronic content in automobiles grew from 35 percent of the vehicle’s cost in 2004 to 41 percent in 2005. Electronics in automobiles will be almost 50 percent of vehicle cost by 2006.

I think you’ll agree that the demand for electrical components is not likely to go away anytime soon. If anything, electronic devices will only get more complicated and more varied—creating a further need for newer and more specialized components.

A Cyclical Business with a Tremendous Upside

Despite that rosy picture, very few electronics companies manage to produce consistent profits. The industry goes through periods of boom followed by periods of bust—too much supply, falling prices, and falling profits. Recent years have been most accurately described as bust.

You can see how AVX’s sales and profits surged in the period from 1999 to 2001. After the peak in 2001, the company’s results basically flatlined. In the 2002–2004 period, the company reported small losses (though it remained cash flow–positive; more on that later). Then, in 2005, AVX reported increasing sales and profits for the first time in years. In looking at Table 2.1, 2005 looks a lot like 1999—and that’s good news.

This was exactly the time to consider buying a company like AVX. The trough was behind it, and the upside remained. When times are good inthis industry, they can be very good. At the peak, the company earned over $3 per share. If you slap a price-earnings ratio of only 10 times on that number, you get $30 per share—more than double the $12 share price at the time.

Still, those were crazy times. We don’t need a return to the 2000 bubble to make good on this investment. AVX routinely generated well over $1 per share in cash flow and reliably cranked out steady free cash flow for several years prior to 2000.

And to AVX’s credit, it generated positive free cash flow even in the industry’s worst years.

In short, AVX is a proven survivor, a resilient competitor in a tough industry.

AVX, however, is clearly operating well below its potential. It has a hidden unappreciated ability to deliver much higher levels of future cash flow.

The Olstein Financial Alert Fund is a respected value shop that practices the art of picking up companies operating at less than their full potential. In fact, this practice has been a critical part of its investment success. I’ve had successes, too, buying companies with cyclically depressed earnings.

Eric Heyman, director of research for Olstein, wrote recently about this aspect of Olstein’s approach. “When a company’s potential is not readily apparent, it tends to sell at a material discount to private market value,” he noted. “Most investors only react to what can be easily seen and don’t undertake further analysis . . . by the time the investment masses identify the changes in the company, the valuation gap is usually closed in rapid fashion.”

In other words, by the time the masses get wind of the positive changes at AVX, the stock price should rise quickly.

Not surprisingly, Olstein owns a $20 million stake in AVX, making it one of the largest institutional investors in AVX. The team at Third Avenue, like- minded tangible asset investors, is the largest institutional investor in AVX, with a $98 million investment—more than 5 percent of the company. Both Olstein and Third Avenue have returned more than double the S&P 500 over the past 10 years. It’s always good to know I’m in such smart company. Then, too, there was that balance sheet. . . .

I love companies with pristine balance sheets. They are ready for any- thing this wild world can throw at them. Plus, cash can be a catalyst for good things to happen—like share buybacks and dividends—not to mention that it gives the company the means to make investments to improve the business.

With $725 million in cash and liquid assets and no debt, AVX fits my profile perfectly. That’s about $4.19 per share in cash assets. Backing all that out of the $12 stock price leaves you paying about $8 for the rest of the business. And keep in mind that this is a business that has the potential to crank out at least a buck per share in cash flow when things are more normal—and a lot more if things get really good.

The median price-to-book ratio over the last 10 years was 2.1. AVX was trading for only 1.5 times book. Just to get to the median, the stock would have to rise 40 percent.

I recommended AVX in October 2005. By April 2006, it had gained over 60 percent.