TCS Daily


Reel In These Stocks

By James K. Glassman - May 21, 2002 12:00 AM

Bottom-fishing can be a dangerous sport. The idea is to find stocks that have submerged so deep that no one pays attention to them. You hook them, and they start rising again. You hope.

Most of the time, individual stocks get cheap for a good reason. Remember that prices are set not at random, but by the actual buying and selling of thousands of investors, who rely on all the public information they can glean. Sometimes, anomalies occur, and you can find a good company selling for an absurdly low price, but humility is usually the right posture to assume before the market. In general, it prices things more accurately than you can.

Also remember that what goes low can stay low -- or can go even lower. When Qwest Communications International, which once traded as high as $66 a share, fell from $35 in May 2001 to $12 in December, it looked cheap. But it kept falling. By early May 2002, it was less than $5.

Still, there's no better feeling than landing a bottom fish. It's a thrill, both intellectually and financially. One of the best approaches to finding such stocks is to focus not on earnings but on assets -- on what the company owns. That was a favorite strategy of the late Benjamin Graham, whose name pops up frequently in this column. Graham was a classics scholar who translated books from Portuguese and taught finance at Columbia University and was a mentor to, among others, Warren Buffett, whom I consider the best investor of the 20th century. Graham was a highly successful investor, too (Geico, the insurance company that's now owned in full by Buffett's Berkshire Hathaway Inc., was one of his huge winners). Graham's firm, Graham-Newman Corp., was a big customer of Tweedy & Co., founded in 1920 by Forrest Berwind Tweedy, a mellifluous Wall Street name. That firm is still around under a slightly different name: Tweedy, Browne Co. (www.tweedy.com).

Tweedy, Browne publishes a brilliant, modest-looking investment booklet called "What Has Worked in Investing" -- a look, through historical data, at which strategies actually pay off. A conclusion it draws is that one of Graham's investing techniques -- buying companies at less than their "net current asset value" (NCAV) -- has been an exceptional winner. The approach utterly ignores profits and concentrates on assets.

What's hard is finding such companies. In Graham's day they were ripe for the picking, but until recently they were extremely scarce in the U.S. market. No longer. Now, according to an article by Jonathan Heller in Bloomberg Personal Finance, there are "hundreds of companies trading below their NCAVs."

Here's how to calculate NCAV: Look up a company's balance sheet on its Web site or Yahoo Finance or practically any other online financial service. Then take its total current assets (basically, the firm's cash, investments, receivables and inventory) and subtract from that figure its current liabilities (short-term debt and payables) plus its long-term debt, preferred stock, pension obligations and leases (all this is easy to find). The result is NCAV. Then compare the number with the company's market capitalization. Graham tried to find companies with market caps that were one-third below NCAV, giving him his famous "margin of safety." In other words, he liked to buy a dollar for 67 cents. Who doesn't?

Many of Heller's discoveries turn out to be high-tech companies that are sitting on piles of cash raised from initial public offerings or venture capitalists but that don't have much in the way of a business. An example is Netro Inc., a wireless-equipment maker that in 2001 registered just $24 million in revenue (down by two-thirds from the previous year) and $79 million in losses. By my own calculation, its NCAV was $190 million (including $206 million in cash, with no debt), and its market cap was $133 million, a discount of 29 percent, or nearly Grahamian proportions.

Of course, the cash goes out the door pretty quickly when you're losing about $1.5 million a week. Netro is one of those firms that is probably worth more dead than alive. Liquidate it and hand the money to investors and they make a 40 percent profit. Unfortunately, managers, who like their jobs, are loath to do such things. Meanwhile, a nasty proxy fight has developed for control of the company -- again, no surprise, considering all that cash lying around.

National Presto Industries, which makes housewares and small appliances, including the beloved SaladShooter and Frydaddy, is another matter. Revenue has risen only about 3 percent annually for the past three years and earnings have declined, but they definitely exist. The company, based in Eau Claire, Wis., has been consistently profitable, and it's paid a nice dividend. Presto's recent NCAV was roughly equal to its market cap, but it had nearly $200 million in cash and short-term investments (pretty much the entire NCAV) and no debt at all.

The problem for National Presto is the lack of a hot new product. While there's abundant cash, the firm cut its dividend last year from $2 to 92 cents -- the lowest payout in at least 15 years. Further bad news is that the stock rose 30 percent from March (when market cap was far below NCAV) to May, but the company gets a good rating from Value Line, and the dividend yield is still a decent 2.6 percent.

Blair Corp., a mail-order apparel company, is another Graham-style firm, with a market cap slightly below its NCAV. While Blair actually makes a profit, look closely at the balance sheet: The current assets are overwhelmingly in receivables, with cash minuscule and debt not insignificant. I'll pass. A better candidate is ValueClick, which is in the unenviable business of selling Internet "advertising solutions." Revenue fell by one-third last year, but the firm managed to reduce its losses significantly. It has an NCAV of $150 million, nearly all in cash, with a recent market cap of $136 million.

How do you find Grahamian candidates? An excellent place to start is the Value Line Investment Survey, which each week lists stocks with the "widest discounts from book value." In fact, such companies are often worth considering, no matter whether they have NCAV discounts or not. Book value is a company's net worth on its balance sheet. It includes plant and equipment -- which are long-term, rather than safer current, assets. Still, the list turns up interesting possibilities. One is Dillard's Inc., the retail chain. It trades at a discount of about one-fourth to book value, but, unlike many cheap stocks, Value Line ranks it "1" (that is, among the top 100 stocks) for year-ahead appreciation potential and "3" (average) for safety. The question with stocks like Dillard's is whether their inventory and their buildings -- which tend to be their main assets -- are really worth what the balance sheet says they're worth. Cash is more reliable.

Consider PacifiCare Health, which owns several health maintenance organizations. Its net worth on the balance sheet is about $2 billion, with 35 million shares outstanding. That comes to a book value per share of about $57, and the stock in early May was trading at just $26. PacifiCare has about $2 billion in cash and short-term investments and $900 million in debt and capitalized leases. Value Line gives the stock a rating of "2" (above-average) for timeliness and "3" (average) for safety but warns that the shares "seem appropriate only for speculative investors" partly because of "relatively limited experience in managing medical expenses under risk-based contracts."

That does not sound good, but you don't find stocks that are both cheap and perfect. PacifiCare expects to recover its equilibrium and earn about $3.45 this year, which gives it a price-to-earnings ratio, or P/E (based on projected profits), of less than 8. And this is a company that in 1999 earned $6.27 and continues to have a powerful cash flow. Again, the stock has risen lately (from a low of just $15 in March). It's risky, but certainly attractive.

What about mutual funds? None (that I can find, anyway) follows the discount-to-assets strategy. But there are a few intriguing alternatives. Two are managed by Tweedy, Browne: American Value and Global Value. Each has a five-star (best) rating from Morningstar and owns stocks that trade at price-to-book (P/B) ratios that are well below the market average of 5. Leading holdings of the American fund include Torchmark Corp., an insurance company with a low P/E and P/B, and PanAmerican Beverages, a Coca-Cola distributor. Global Value's top two stocks at last report were Nestle, the Swiss food giant, and Bayer, the German-based chemical and drug company.

The third intriguing fund is Excelsior Value and Restructuring, which has beaten the majority of its peers in eight of the past 10 years, has whipped the benchmark Standard & Poor's 500-stock index by an annual average of 14 percentage points over the past three years and also possesses five Morningstar stars. Manager David Williams looks for fallen heroes and isn't afraid to invest in technology stocks such as Vishay Intertechnology, which has a low P/B, significant cash and little short-term debt. Vishay, which makes electronic components, had a terrible year in 2001 but earned $3.75 a share in 2000 and was recently trading at just $20.91.

Do not, however, simply swallow my tips. Cast for your own bottom fish -- online or elsewhere. Just remember that, while discounts to book value and net asset value are alluring, earnings do count. A company with fabulous assets, no debt and a lousy business may never be liquidated or bought out, so you're left sitting with a fishy investment that will start to stink. Still, in this market there's little reason to flounder.

A version of this article appeared in the Washington Post.
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