Benjamin Graham and David Dodd, widely considered to be the
fathers of modern investing philosophy, had a deep affinity for
value stocks. They taught disciples such as Warren Buffett to
assess companies in the most pessimistic possible scenarios. This
makes sense. These men wrote their famous book,
, in 1934, when companies were liquidating at a fast pace during
the GreatDepression .
One of their favorite techniques: Net/net investing. This looks at
what a company would be worth in a time of absolute distress.
Specifically: what would a company have left if you piled up its
, paid off its liabilities and returned the funds to shareholders?
(Graham and Dodd applied a slight discount to the value of
inventory and accounts receivable, but I am not because companies
do a much better job these days of writing down those assets to
reflect realistic expected values than they did back in the 1930s.)
As you might imagine, these companies are cheap for a reason.
They're not operating at peak performance. So you don't want to
measure them by current metrics such as operating
. Instead, you want to see if their business models hold any
long-term appeal, since you're basically getting the business for
nothing (or in this case, less than nothing).
Digging into the
To truly find a "net/net" investment, you need to have accurate
numbers on the balance sheet.
Avatar Holdings (Nasdaq:
developer focused on Florida and Arizona, is a good test case. The
company is sitting on more than $300 million in unsold homes, far
above the company's stock value. This figure is the cost incurred
to acquire the land and build on it. Are those homes still worth
that much? Clearly not. Then again, you have to assume real estate
in those states will improve
. In the meantime, Avatar has more than $150 million in the bank,
which is more than enough to ride out the current crisis.
The real estate crisis broughtshares down from $80 in 2007 to $20
by 2009, where they had sat ever since. But the recent market rout
all the way down to $10, moving this squarely into net/net
A worthless business?
As noted earlier, you have to look at what these businesses might
be worth in a different economic climate and not simply what they
look like right now. Case in point, micro-cap stock
Gencor Industries (Nasdaq:
, which is struggling from very weak demand for asphalt and other
road-building materials. State and federal government finances are
in bad shape, and a rising number of projects are on hold. This can
only last so long because we'll again need to invest in repairs of
existing roads and the construction of new ones.
Gencor, back in "normal" times, earned an average of $2 a share
from fiscal (September) 2005 through fiscal 2008. It's a hopeful
sign the company just announced a solid boost in quarterly sales
and a decent
.Fiscal third quarter sales rose 81% to $23 million and a $1.5
million loss a year ago was boosted to a $1.5 million in this third
quarter. This is money that goes to the balance sheet,
pumping up an already-considerable net cash balance. Cash exceeds
the entire value of the company, which should provide major
downside protection in these challenging times.
Risks to consider:
The challenge for these companies is to preserve their
base during this economic slowdown. Money-losing quarters have a
way of eroding cash and
Action to Take --> All of these stocks require a good deal more
research because they tend to operate off-the-radar and have clear
challenges that need to be understood. But the extremely low values
assigned to their businesses imply that any operational rebound
would quickly bring investors back into the fold.
-- David Sterman
The One Stock to Buy BEFORE President Obama's Emergency Briefing
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.