The superb Manual of Ideas blog has an article by Ravi Nagarajan, Marty Whitman Reflects on Value Investing and Net-Nets, on legendary value investor Marty Whitman’s conversation with Columbia Professor Bruce Greenwald at the Columbia Investment Management Conference in New York. I have in the past discussed Marty Whitman’s adjustments to Graham’s net net formula, which I find endlessly useful. Whitman has some additional insights that I believe are particularly useful to net net investors:
“Cheap is Not Sufficient”
At several points in the discussion with Prof. Greenwald, Mr. Whitman came back to a central theme: It is not sufficient for a security to be “cheap”. It must also possess a margin of safety as demonstrated by a strong balance sheet and overall credit worthiness. In other words, there are many securities that may appear cheap statistically based on a number of common criteria investors use to judge “cheapness”. This might include current year earnings compared to the stock price, current year cash flow, and many others. However, if the business does not have a durable balance sheet, adverse situations that are either of the company’s own making or due to macroeconomic factors can determine the ultimate fate of the company. A durable balance sheet demonstrates the credit worthiness a business needs to manage through periodic adversity.
Whitman also discusses an issue near and dear to my heart: good corporate governance, and, by implication, activism:
One other point that Mr. Whitman made while discussing corporate governance also applies to many net-net situations. The true value of a company may never come out if there is no threat of a change in control. This obviously makes intuitive sense because the presence of a very cheap company alone will not result in realization of value unless management is willing to act in the interests of shareholders either by liquidating a business that has no future prospects but a very liquid balance sheet or taking steps to improve the business.
Read the balance of the article at The Manual of Ideas blog.