Feeds:
Posts
Comments

Archive for the ‘Liquidation Value’ Category

Last week I wrote about the performance of one of Benjamin Graham’s simple quantitative strategies over the 37 years he since he described it (Examining Benjamin Graham’s Record: Skill Or Luck?). In the original article Graham proposed two broad approaches, the second of which we examine in Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors. The first approach Graham detailed in the original 1934 edition of Security Analysis (my favorite edition)—“net current asset value”:

My first, more limited, technique confines itself to the purchase of common stocks at less than their working-capital value, or net-current asset value, giving no weight to the plant and other fixed assets, and deducting all liabilities in full from the current assets. We used this approach extensively in managing investment funds, and over a 30-odd year period we must have earned an average of some 20 per cent per year from this source. For a while, however, after the mid-1950’s, this brand of buying opportunity became very scarce because of the pervasive bull market. But it has returned in quantity since the 1973–74 decline. In January 1976 we counted over 300 such issues in the Standard & Poor’s Stock Guide—about 10 per cent of the total. I consider it a foolproof method of systematic investment—once again, not on the basis of individual results but in terms of the expectable group outcome.

In 2010 I examined the performance of Graham’s net current asset value strategy with Sunil Mohanty and Jeffrey Oxman of the University of St. Thomas. The resulting paper is embedded below:

While Graham found this strategy was “almost unfailingly dependable and satisfactory,” it was “severely limited in its application” because the stocks were too small and infrequently available. This is still the case today. There are several other problems with both of Graham’s strategies. In Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors Wes and I discuss in detail industry and academic research into a variety of improved fundamental value investing methods, and simple quantitative value investment strategies. We independently backtest each method, and strategy, and combine the best into a sample quantitative value investment model.

The book can be ordered from Wiley FinanceAmazon, or Barnes and Noble.

[I am an Amazon Affiliate and receive a small commission for the sale of any book purchased through this site.]

About these ads

Read Full Post »

Zero Hedge has an article Buy Cash At A Discount: These Companies Have Negative Enterprise Value in which Tyler Durden argues that stock market manipulation has led to valuation dislocations, and gives as evidence the phenomenon of stocks trading with a negative enterprise value (EV):

With humans long gone from the trading arena and algorithms left solely in charge of the casino formerly known as “the stock market”, in which price discovery is purely a function of highly levered synthetic instruments such as ES and SPY or, worse, the EURUSD and not fundamentals, numerous valuation dislocations are bound to occur. Such as company equity value trading well below net cash (excluding total debt), or in other words, negative enterprise value, meaning one can buy the cash at a discount of par and assign zero value to all other corporate assets.

Just as the fact of your paranoia does not exclude the possibility that someone is following you*, you don’t need to believe in manipulation to believe that negative EV is a “valuation dislocation.” Negative EV stocks are often also Graham net nets or almost net nets, and so perform like net nets. For example, Turnkey Analyst took a look at the performance of negative EV stocks (click to enlarge):

Long story short: they ripped, but they were few (sometimes non-existent), and small (mostly micro), which means you would have been heavily concentrated in a few mostly very small stocks, and regularly carried a lot of cash. If you eliminated the tiniest (i.e. the smallest 10 or 20 percent), much of the return disappeared, and volatility spiked markedly. Says Wes:

A few key points:

  1. After you eliminate the micro-crap stocks, you end up being invested in a few names at a time (sometimes you go all-in on a single firm!)
  2. Sometimes the strategy isn’t invested.
  3. The amazing Bueffettesque returns for the “all firms” portfolio above are exclusively tied to micro-craps.

Here’s the frequency of negative EV opportunities according to Turnkey (click to enlarge):

No surprise, there were more following a crash (1987, 2001, 2009) and fewer at the peak (1986, 1999, 2007). If your universe eliminated the smallest 20 percent (the green line), you spent a lot of time in cash. If your universe was unrestricted (the red line), then you’d have had some prospects to mine most of the time. Clearly, it’s not an institutional-grade strategy, but it has worked for smaller sums.

Zero Hedge screened Russell 2000 companies finding 10 companies with negative enterprise value, and then further subdivided the screen into companies with negative, and positive free cash flow (defined here as EBITDA – Cap Ex). Here’s the list (click to enlarge):

Including short-term investments yields a bigger list (click to enlarge):

Like Graham net nets, negative EV stocks are ugly balance sheet plays. They lose money; they burn cash; the business, if they actually have one, usually needs to be taken to the woodshed (so does management, for that matter). Frankly, that’s why they’re cheap. Says Durden:

Typically negative EV companies are associated with pre-bankruptcy cases, usually involving large cash burn, in other words, where the cash may or may not be tomorrow, and which may or may not be able to satisfy all claims should the company file today, especially if it has some off balance sheet liabilities.

You can cherry-pick this screen or buy the basket. I favor the basket approach. Just for fun, I’ve formed four virtual portfolios at Tickerspy to track the performance:

  1. Zero Hedge Negative Enterprise Value Portfolio
  2. Zero Hedge Negative Enterprise Value Portfolio (Positive FCF Only)
  3. Zero Hedge Negative Enterprise Value (Inc. Short-Term Investments) Portfolio
  4. Zero Hedge Negative Enterprise Value (Inc. Short-Term Investments) Portfolio (Positive FCF Only)

I’ll check back in occasionally to see how they’re doing. My predictions for 2013:

  1. All portfolios beat the market
  2. Portfolio 1 outperforms Portfolio 2 (i.e. all negative EV stocks outperform those with positive FCF only)
  3. Portfolio 3 outperforms Portfolio 4 for the same reason that 1 outperforms 2.
  4. Portfolios 1 and 2 outperform Portfolios 3 and 4 (pure negative EV stocks outperform negative EV including short-term investments)

Take care here. The idiosyncratic risk here is huge because the portfolios are so small. Any bump to one stock leaves a huge hole in the portfolio.

* Turn around. I’m right behind you.

Read Full Post »

Kinnaras Capital Management has sent a follow up letter to Media General Inc (NYSE:MEG) requesting the board “selloff MEG in its entirety and divorce this company from the inept management team currently at the helm.”

In its earlier letter Kinnaras expressed frustration with the performance of MEG, and urged the Board to “take advantage of the robust M&A market for both newspaper and broadcast television and to sell all operating units of MEG in order to retire existing corporate and pension debt and achieve a share price shareholders have rarely seen in recent years.”

MEG is a provider of local news in small and mid-size communities throughout the Southeastern United States. It owns three metropolitan and 20 community newspapers and 18 network-affiliated broadcast television stations Virginia/Tennessee, Florida, Mid-South, North Carolina, and Ohio/Rhode Island.

The initial letter included Kinnaras’s sum-of-the-parts valuation, which Kinnaras Managing Member Amit Chokshi sees at $9.75 per share against a prevailing price of around $4.60.

Here’s the follow up letter:

Kinnaras also has on its website its recommendations to MEG shareholders ahead of the proxy vote.

No position.

Read Full Post »

Kinnaras Capital Management has sent an open letter to Media General Inc (NYSE:MEG) expressing frustration with the performance of the company and “urging the Board to take advantage of the robust M&A market for both newspaper and broadcast television and to sell all operating units of MEG in order to retire existing corporate and pension debt and achieve a share price shareholders have rarely seen in recent years.”

MEG is a provider of local news in small and mid-size communities throughout the Southeastern United States. It owns three metropolitan and 20 community newspapers and 18 network-affiliated broadcast television stations Virginia/Tennessee, Florida, Mid-South, North Carolina, and Ohio/Rhode Island.

The letter includes Kinnaras’s sum-of-the-parts valuation, which Kinnaras Managing Member Amit Chokshi sees at $9.75 per share against a prevailing price of around $4.60.

Here’s the letter:

It seems like a promising situation.

No position.

Read Full Post »

Walter Schloss, one of Warren Buffett’s Superinvestors of Graham-and-Doddsville, has died at 95.

Says Bloomberg:

From 1955 to 2002, by Schloss’s estimate, his investments returned 16 percent annually on average after fees, compared with 10 percent for the Standard & Poor’s 500 Index.

His firm, Walter J. Schloss Associates, became a partnership, Walter & Edwin Schloss Associates, when his son joined him in 1973.

“He was a true fundamentalist,” Edwin Schloss, now retired, said today in an interview. “He did his fundamental analysis and was very concerned that he was buying something at a discount. Margin of safety was always essential.”

Buffett, another Graham disciple, called Schloss a “superinvestor” in a 1984 speech at Columbia Business School.

He again saluted Schloss as “one of the good guys of Wall Street” in his 2006 letter to shareholders of his Berkshire Hathaway Inc.

“Following a strategy that involved no real risk — defined as permanent loss of capital — Walter produced results over his 47 partnership years that dramatically surpassed those of the S&P 500,” wrote Buffett, whose stewardship of Berkshire

Hathaway (BRK) has made him one of the world’s richest men and most emulated investors. “It’s particularly noteworthy that he built this record by investing in about 1,000 securities, mostly of a lackluster type. A few big winners did not account for his success.”

For more on Schloss and his outstanding record, see Walter Schloss, superinvestor.

Read Full Post »

The Fall 2010 edition of the Graham and Doddsville Newsletter, Columbia Business School‘s student-led investment newsletter co-sponsored by the Heilbrunn Center for Graham & Dodd Investing and the Columbia Investment Management Association, has a fascinating interview with Donald G. Smith. Smith, who volunteered for Benjamin Graham at UCLA, concentrates on the bottom decile of price to tangible book stocks and has compounded at 15.3% over 30 years:

G&D: Briefly describe the history of your firm and how you got started?

DS: Donald Smith & Co. was founded in 1980 and now has $3.6 billion under management. Over 30 years since inception our compounded annualized return is 15.3%. Over the last 10 years our annualized return is 12.1% versus −0.4% for the S&P 500.

Our investment philosophy goes back to when I was going to UCLA Law School and Benjamin Graham was teaching in the UCLA Business School. In one of his lectures he discussed a Drexel Firestone study which analyzed the performance of a portfolio of the lowest P/E third of the Dow Jones (which was the beginning of ―Dogs of the Dow 30). Graham wanted to update that study but he didn‘t have access to a database in those days, so he asked for volunteers to manually calculate the data. I was curious about this whole approach so I decided to volunteer. There was no question that this approach beat the market. However, doing the analysis, especially by hand, you could see some of the flaws in the P/E based approach. Based on the system you would buy Chrysler every time the earnings boomed and it was selling at only a 5x P/E, but the next year or two they would go into a down cycle, the P/E would expand and you were forced to sell it. So in effect, you were often buying high and selling low. So it dawned on me that P/E and earnings were too volatile to base an investment philosophy on. That‘s why I started playing with book value to develop a better investment approach based on a more stable metric.

G&D: There are plenty of studies suggesting that the lowest price to book stocks outperform. However, only 1/10 of 1% of all money managers focus on the lowest decile of price to book stocks. Why do you think that‘s so, and how do people ignore all of this evidence?

DS: They haven‘t totally ignored it. There are periods of time when quant funds, in particular, use this strategy. However a lot of the purely quant funds buying low price to book stocks have blown up, as was the case in the summer of 2007. Now not as many funds are using the approach. Low price to book stocks tend to be out-of-favor companies. Often their earnings are really depressed, and when earnings are going down and stock prices are going down, it‘s a tough sell.

G&D: Would you mind talking about how the composition of that bottom decile has changed over time? Is it typically composed of firms in particular out of favor industries or companies dealing with specific issues unique to them?

DS: The bulk is companies with specific issues unique to them, but often there is a sector theme. Back in the early 1980‘s small stocks were all the rage and big slow-growing companies were very depressed. At that time we loaded up on a lot of these large companies. Then the KKR‘s of the world started buying them because of their stable cash flow and the stocks went up. About six years ago, a lot of the energy-related stocks were very cheap. We owned oil shipping, oil services and coal companies trading below book and liquidation value. When oil went up they became the darlings of Wall Street. Over the years we have consistently owned electric utilities because there always seem to be stocks that are temporarily depressed because of a bad rate decision by the public service commission. Also, cyclicals have been a staple for us over the years because, by definition, they go up and down a lot which gives us buying opportunities. We‘ve been in and out of the hotel group, homebuilders, airlines, and tech stocks.

Performance of the low-price-to-tangible book value:

Read the Graham and Doddsville newsletter Fall 2010 (.pdf).

Hat tip George.

Read Full Post »

For a period from late 2008 through mid 2009 the GSI Group (PINK:LASR) was prima facie the cheapest stock on my net net screen, but I couldn’t pull the trigger because it was delinquent a few quarterly filings. The company entered Chapter 11 due to the technical default of not filing financial statements and is now an extremely interesting prospect post reorganization. The superb Above Average Odds Investing blog has a guest post from Ben Rosenzweig, an analyst at Privet Fund Management, titled The GSI Group (LASR.PK) – Another Low-Risk, High-Return Post Reorg Equity w/ Substantial Near-Term Catalyst(s), which really says it all. Here’s the summary:

Thesis Summary: Privet Fund LP is long GSIGQ common stock. Our post-emergence price target is $5.00 per common share, an internal rate of return of 123% based on closing price of $2.70 and right to purchase .99 shares for every 1 share currently owned at a price of $1.80 per share. The market has failed to fully price in the impact of the Plan of Reorganization that was confirmed on Thursday, May 27, 2010.

We believe GSI is an attractive investment opportunity for the following reasons:

  • Due to the efforts of the equity committee throughout the bankruptcy process, the pre-emergence equity holders will be able to maintain an 87% ownership in the post-emergence company, up from an initial distribution of 18.6% in the first Plan of Reorganization
  • The end markets for the Company’s precision technology and semiconductor products are coming out of the trough of a cycle and, as a result, GSI’s bookings have been increasing at an exponential rate
  • The purging of the previous management regime opens the door for an experienced operator to run the Company much more efficiently and make strategic decisions with a view toward enhancing the value of the enterprise
  • The significant reduction in debt gives management the needed flexibility to focus solely on improving operations. This should result in significant fixed cost leverage going forward as evidenced by the Q1 2010 EBITDA margin of 14%, a figure that previous management suggested was not achievable until the end of 2011
  • The current market valuation, which includes the right to buy .99 shares at $1.80 per share, implies a 2010 sales figure and discounted cash flow valuation that is simply not possible even if the Company’s financial performance does not follow through on the radical improvements that have been shown during the past two quarters

Read the post in full.

Read Full Post »

Older Posts »

Follow

Get every new post delivered to your Inbox.

Join 4,780 other followers

%d bloggers like this: