Dust off your old notes because this month’s review begins with a pop quiz. The subject is microeconomics. Each of the questions has to do with the investment story behind one of the stocks we highlighted in February 2011.

1) What term describes an industry in which it is most cost-efficient for a single firm to provide all the industry output?

2) The managers of a growing business discover that the more customers the business adds, the cheaper it becomes to add new products to sell. What type of “economies” is the business benefiting from? (Hint: not “economies of scale,” but close.)

Just one more question:

3) Assume the market price for a company's shares follows the normal laws of supply and demand. A company suddenly reduces its total shares outstanding by 10%. Demand remains unchanged. Should the company’s price go up, go down, or remain unchanged?

Solutions follow below. Let's look at a company whose investment case springs straight from the pages of an economics textbook. In February 2011, we profiled NeuStar, Inc. (Ticker: NSR) in the Investor Advisory Service. The telecom infrastructure company exhibited a history of steady growth, as well as attractive cash flows and a reasonable valuation. At the time of our profile, shares traded at 27.84. At a recent price of 34, the stock is up 22% since the time of selection. The S&P 500 is down 3% over the same period, although total returns for the market are closer to zero, including dividends.

In the four fiscal quarters since we profiled NeuStar, the company has shown generally positive trends. Quarterly sales have grown at a rate of 3%, 14%, 16%, and 18%, while EPS grew 11%, 21%, 7%, and 21%. Much of that growth is built into the company’s business model, which provides for predictable step-ups in pricing. In particular, more than half of NeuStar’s revenue comes from managing the central directory which matches phone numbers with phones, as well as with people. Telecom companies query NeuStar’s directory whenever a customer moves to a new carrier or switches to a new phone. The necessity of maintaining a single, national phone directory also provides a great example of the answer to Question #1, a "natural monopoly." With monopoly often comes regulation, however, and regulation brings uncertainty. The portability contract is currently up for review. While NeuStar CEO Lisa Hook expresses confidence that NeuStar will retain the contract, how can investors really be so sure?

The intended answer to Question #2 is "economies of scope." In conjunction with offering portability service, NeuStar also supplies related value-added services to its large telecom customers. The company has relied on acquisitions to enter adjacent fields, and those acquisitions have frequently failed to live up to expectations. Meanwhile, we’ve been annoyed by NeuStar’s increasing operating costs, paired with slim organic growth.

When we first profiled NeuStar, the company’s balance sheet boasted a large surplus of current assets relative to total liabilities. That changed recently, when NeuStar acquired Targus Information Corp for $650 million. In conjunction with the acquisition, NSR also repurchased 10% of its outstanding shares in an "accelerated buyback." When the supply of something decreases, the price generally goes up (Question #3). By sucking up all those available shares, NSR has managed to boost its stock price up into the low 30’s. It looks a little, um, funny when a company employs accelerated buybacks and other such tricks, but the result has been good for shareholders, at least so far. With all the uncertainty related to the number portability contract, along with a newly-levered balance sheet, the character of this investment has changed substantially over the last twelve months. The current price is above our buy-up-to level of $32. Successfully renewing the number portability contract on good terms would probably lead to a much higher stock price. Any negative news on that front could have severe negative consequences for investors, however.

Disclaimer:  This company was selected for review in part because of its performance over the past year. Any outperformance relative to the broader market is not necessarily indicative of performance of the broader Investor Advisory Service.