Greenbackd

Greenbackd is dedicated to unearthing undervalued asset situations where a catalyst exists likely to remove the discount or unlock the value.

Our philosophy: Undervalued asset situations

Greenbackd seeks securities trading at a substantial discount to asset value. Several studies demonstrate that undervalued asset strategies generate returns in excess of the market:

1. Roger Ibbotson, a Professor in the Practice of Finance at Yale School of Management and President of Ibbotson Associates, Inc., a consulting firm specializing in economics, investments and finance, published a study called “Decile Portfolios of the New York Stock Exchange, 1967 – 1984,” Working Paper, Yale School of Management, 1986, in which he studied the relationship between stock price as a proportion of book value and investment returns. Ibbotson found that stocks with a low price-to-book value ratio had significantly better investment returns over the 18-year period than stocks priced high as a proportion of book value.
2. A further study conducted by Werner F.M. DeBondt and Richard H. Thaler, Finance Professors at University of Wisconsin and Cornell University, respectively, examined stock price in relation to book value in “Further Evidence on Investor Overreaction and Stock Market Seasonality,” The Journal of Finance, July 1987. DeBondt and Thaler ranked all companies listed on the NYSE and AMEX, except companies that were part of the S&P 40 Financial Index, according to stock price in relation to book value and then sorted them into quintiles on December 31 in each of 1969, 1971, 1973, 1975, 1977 and 1979. DeBondt and Thaler then calculated the investment return against the equal weighted NYSE Index over the subsequent four years for all of the stocks in each selection period. The four-year returns against the market index were then averaged. DeBondt and Thaler found a cumulative average return in excess of the market index over the four years of 40.7%.
3. Research undertaken by Professor Henry Oppenheimer on Benjamin Graham’s liquidation value strategy between 1970 and 1983 called “Ben Graham’s Net Current Asset Values: A Performance Update” found “[the] mean return from net current asset stocks for the 13-year period was 29.4% per year versus 11.5% per year for the NYSE-AMEX Index. One million dollars invested in the net current asset portfolio on December 31, 1970 would have increased to $25,497,300 by December 31, 1983.”
4. Value vs Glamour: A Global Phenomenon is a recent paper by The Brandes Institute updating Contrarian Investment, Extrapolation and Risk, the landmark 1994 study by Josef Lakonishok, Andrei Shleifer, and Robert Vishny. It investigates the performance of value stocks (defined as the lowest decile of stocks by price-to-book) relative to that of glamour securities in the United States over a 40-year period, and extends the scope of the initial study to include non-U.S. markets, to determine whether the value premium is evident worldwide. They conclude that value stocks tend to outperform glamour stocks and by wide margins.

Why might this be so? We venture three possible explanations below:

1. Assets are simpler to value than unknown future earnings. It’s been our experience that earnings are often difficult to forecast with any degree of accuracy and it’s simply not possible to value a security based on unknown future earnings. Assets, on the other hand, are known quantities at the time of filing, although this is not to say that the value of the assets recorded in the filing is the value we would ascribe to them. When we value the assets, we disregard intangible assets, heavily discount long-term and fixed assets, and apply a modest discount to receivables and inventories. We take cash and marketable securities at face value. For these reasons, we prefer that each security is predominantly backed by cash, hence our name: Greenbackd. Perhaps the most striking finding by DeBondt and Thaler in the “Further Evidence on Investor Overreaction and Stock Market Seasonality” study discussed above, and one that accords with our view about the difficulty of predicting earnings with any degree of accuracy, is the contrast between the earnings pattern of the companies in the lowest quintile (average price/book value of 0.36) and the highest quintile (average price/book value of 3.42). In the four years after the date of selection, the earnings of the companies in the lowest price/book value quintile increase 24.4%, more than the companies in the highest price/book value quintile, whose earnings increased only 8.2%. DeBondt and Thaler attribute the earnings outperformance of the companies in the lowest quintile to the phenomenon of “mean reversion,” which noted deep value investors Tweedy Browne describe as the observation that “significant declines in earnings are followed by significant earnings increases, and that significant earnings increases are followed by slower rates of increase or declines.”
2. By focusing on assets we are forced to consider the downside first, which is the security’s value in a liquidation.  This forces us to be conservative in our assessment of value.
3. Assets are a contrarian measure of value. It seems to us that, to the extent that Wall Street makes any assessment of value, it is obsessed with earnings. Wall Street no longer pays any attention to what a company owns. We believe that this presents an opportunity where a valuation based on a company’s earnings underestimates the company’s asset value. Research seems to support this view: Only 24% of value investors incorporate the classic value technique of focusing on tangible asset undervaluation.

Our favorite stocks are those trading at a substantial discount to net current assets or liquidation value.

The catalyst

A catalyst is some form of corporate action that causes the market price of a security to rise to its asset value. It can take the form of a return of capital, special dividend, stock buyback, sale of a key asset, takeover or similar value-enhancing act. These actions can be undertaken by management, but are more often imposed on a company by activist investors or other stockholders dissatisfied with management. It is worth mentioning that the market does sometimes spontaneously recognize the underlying asset value and remove the discount.  Without a catalyst, however, the regression of the market price to the asset value can take a long time, if it occurs at all.  We prefer securities with the conditions in place for a likely catalytic event.

Activist investors are one such source of catalytic events. Research supports the view that stocks the subject of activist campaigns can generate above market returns:

1. In Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors, April Klein and Emanuel Zur examined recent “confrontational activism campaigns” by “entrepreneurial shareholder activists” and conclude that such strategies generate “significantly positive market reaction for the target firm around the initial Schedule 13D filing date” and “significantly positive returns over the subsequent year.” The paper confirms our view that the filing of a 13D notice by an activist hedge fund is a catalytic event for a firm that heralds substantial positive returns in the stock. Klien and Zur found that “hedge fund targets earn 10.2% average abnormal stock returns during the period surrounding the initial Schedule 13D. Other activist targets experience a significantly positive average abnormal return of 5.1% around the SEC filing window. These findings suggest that, on average, the market believes activism creates shareholder value. … Furthermore, our target abnormal returns do not dissipate in the 1-year period following the initial Schedule 13D. Instead, hedge fund targets earn an additional 11.4% abnormal return during the subsequent year, and other activist targets realize a 17.8% abnormal return over the year following the activists’ interventions.”
2. In Hedge Fund Activism, Corporate Governance, and Firm Performance, authors Brav, Jiang, Thomas and Partnoy found that the “market reacts favorably to hedge fund activism, as the abnormal return upon announcement of potential activism is in the range of [7%] seven percent, with no return reversal during the subsequent year.” Further, the paper “provides important new evidence on the mechanisms and effects of informed shareholder monitoring.”
3. Ramius Capital’s whitepaper, The case for activist strategies, seeks to explain how activist investment strategies create shareholder value and improve corporate governance by resolving conflicts of interest between shareholders, directors and management.

Another source of potential catalysts are reverse mergers in shell companies. In Shell Games: On the Stock Price Performance of Shell Companies, Ioannis V. Floros and Travis R. Sapp examined the stock price performance of shell companies over the period 2006 to 2008, finding that “[when] a takeover agreement is consummated, shell company three-month abnormal returns are 48.1%.”

Measuring performance

We believe that our performance should be assessed against a relevant benchmark, which we believe to be the S&P 500 Index because it is widely published and followed, and approximates the return of the general stock market. As of today, December 1st, 2008, the S&P 500 Index stands at 896.24 (its November 28, 2008 close). For each security we identify, we will record the most recent price for that security and for the S&P 500 Index so that, over time (two to five years), it will be possible to determine whether our strategy is worthwhile.

Benjamin Graham

It would be remiss of us not to acknowledge the great intellectual debt Greenbackd owes Benjamin Graham and his magnum opus, Security Analysis.  Chapters 43 (Significance of the Current-Asset Value) and 44 (Implications of Liquidating Value. Stockholder-Manager Relationships) of the 1934 Edition continue to provide the theoretical framework for all that we do.

Syndication

Greenbackd is a “Gold Standard” contributor to Seeking Alpha, which means that we have agreed in writing to abide by Seeking Alpha’s full compliance standards.

We are a GuruFocus “Guru”.

Contact us

We can be contacted at greenbackd [at] gmail [dot] com.

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