ValuePlays

In his own words…

We are clearly in a serious recession, and more aggressive action is needed to turn things around. The federal government initially underestimated the scale of the mortgage and housing crises and later panicked into an ever-changing series of ad hoc measures that at best dealt with some of the effects of the original crises. But homeowners have now lost $5 trillion, and 12 million families have mortgages in excess of the value of their homes. Therefore the economy will not stabilize until mortgages are adjusted down to the value of homes, with affordable payment schedules, and until new mortgages become available across the home-price spectrum. Till then, the poverty effect of falling house prices and unemployment moving up toward 7% will hold consumer spending back from its former 70% contribution to our economy.

I’m optimistic about the choices that President-elect Obama has made for his economic team, and I’ve got some suggestions for what they should do. Hopefully the new Treasury Secretary, Tim Geithner, will incentivize lenders to restructure mortgages by guaranteeing half of the reduced principal amount and sharing among the government, homeowners, and lenders any subsequent appreciation. Lenders would gain liquidity by selling the Treasury-guaranteed portion of the loan, and government would receive annual insurance premiums to further protect it against loss. That would cost taxpayers nothing now and probably little or nothing in the future.

Addressing unemployment is paramount. Detroit needs government support in order to implement independently verified concessions from all stakeholders – not just labor – which are sufficiently large to permit profitable operations even if auto sales remain as low as 11 million cars per year. A pre-negotiated bankruptcy may be necessary in order to implement the restructuring, but both the industry and the economy are too fragile to withstand the domino effect that a free-fall bankruptcy would have on a car company, its dealers, and its suppliers.

In addition, to avoid reversal of the 242,000 jobs created by state and local governments in the past 12 months, Washington should provide or guarantee funding for sorely needed infrastructure projects that would create immediate construction jobs and meaningful amounts of permanent jobs.

If President Obama promptly and decisively resolves these problems, whether or not he adopts my recommendations, and restores public confidence, he can end the recession by early 2010. If not, the economy will languish for a long time. Given the economic uncertainty, investors who are too worried to buy equities might consider tax-exempt bonds with yields around 6%, equivalent to almost 10% before federal, state, and local taxes. Investors who want to hedge the risk that federal deficits might lead to longer-term inflation and drive up interest rates, causing these bonds to decline, might buy some TIPS, or Treasury inflation-protected securities, as well. TIPS are U.S. Treasury bonds whose principal amount varies with consumer price indexes to provide holders with a rate of return in constant dollars. TIPS prices currently imply near-term deflation, and that means that they would appreciate in value if inflation comes back.

At my firm, we’ve been starting to invest in some distressed financial companies. That seems as if it will work out reasonably well, because they’re very, very cheap. The financial services sector is kind of where the problems started, and it’s probably going to need to be fixed in order for the problems to be resolved. We see opportunities there.

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From Tweedy -Browne..

ASSETS BOUGHT CHEAP
BENJAMIN GRAHAM’S NET CURRENT ASSET VALUE STOCK SELECTION CRITERION
The net current asset value approach is the oldest approach to investment in groups of securities with common selection characteristics of which we are aware. Benjamin Graham developed and tested this criterion between 1930 and 1932.

The net current assets investment selection criterion calls for thepurchase of stocks which are priced at 66% or less of a company’s underlying current assets (cash,receivables and inventory) net of all liabilities and claims senior to a company’s common stock (currentliabilities, long-term debt, preferred stock, unfunded pension liabilities).

For example, if a company’scurrent assets are $100 per share and the sum of current liabilities, long-term debt, preferred stock, and unfunded pension liabilities is $40 per share, then net current assets would be $60 per share, and Grahamwould pay no more than 66% of $60, or $40, for this stock. Graham used the net current asset investmentselection technique extensively in the operations of his investment management business, Graham-Newman Corporation, through 1956.

Graham reported that the average return, over a 30-year period, ondiversified portfolios of net current asset stocks was about 20% per year.In the 1973 edition of The Intelligent Investor, Benjamin Graham commented on the technique:”It always seemed, and still seems, ridiculously simple to say that if one can acquire adiversified group of common stocks at a price less than the applicable net current assetsalone — after deducting all prior claims, and counting as zero the fixed and other assets –the results should be quite satisfactory.”

In an article in the November-December 1986 issue of Financial Analysts Journal, “Ben Graham’s Net Current Asset Values: A Performance Update,” Henry Oppenheimer, an Associate Professor of Finance atthe State University of New York at Binghamton, examined the investment results of stocks selling at orbelow 66% of net current asset value during the 13-year period from December 31, 1970 throughDecember 31, 1983.The study assumed that all stocks meeting the investment criterion were purchased on December 31 ofeach year, held for one year, and replaced on December 31 of the subsequent year by stocks meeting the same criterion on that date.

To create the annual net current asset portfolios, Oppenheimer screened theentire Standard & Poor’s Security Owners Guide. The entire 13-year study sample size was 645 netcurrent asset selections from the New York Stock Exchange, the American Stock Exchange and the over-the-counter securities market. The minimum December 31 sample was 18 companies and the maximum December 31 sample was 89 companies.

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 onDecember 31, 1970 would have increased to $25,497,300 by December 31, 1983. By comparison,$1,000,000 invested in the NYSE-AMEX Index would have increased to $3,729,600 on December 31,1983.

The net current asset portfolio’s exceptional performance over the entire 13 years was notconsistent over smaller subsets of time within the 13-year period. For the three-year period, December31, 1970 through December 31, 1973, which represents 23% of the 13-year study period, the mean annualreturn from the net current asset portfolio was .6% per year as compared to 4.6% per year for the NYSE-AMEX Index.The study also examined the investment results from the net current asset companies which operated at aloss (about one-third of the entire sample of firms) as compared to the investment results of the netcurrent asset companies which operated profitably.

The firms operating at a loss had slightly higherinvestment returns than the firms with positive earnings: 31.3% per year for the unprofitable companiesversus 28.9% per year for the profitable companies.Further research by Tweedy, Browne has indicated that companies satisfying the net current assetcriterion have not only enjoyed superior common stock performance over time but also often have beenpriced at significant discounts to “real world” estimates of the specific value that stockholders wouldprobably receive in an actual sale or liquidation of the entire corporation.

Net current asset value ascribes no value to a company’s real estate and equipment, nor is any going concern value ascribed to prospectiveearning power from a company’s sales base. When liquidation value appraisals are made, the estimated”haircut” on accounts receivable and inventory is often recouped or exceeded by the estimated value of acompany’s real estate and equipment. It is not uncommon to see informed investors, such as a company’sown officers and directors or other corporations, accumulate the shares of a company priced in the stockmarket at less than 66% of net current asset value. The company itself is frequently a buyer of its own shares.

Common characteristics associated with stocks selling at less than 66% of net current asset value are lowprice/earnings ratios, low price/sales ratios and low prices in relation to “normal” earnings; i.e., what thecompany would earn if it earned the average return on equity for a given industry or the average netincome margin on sales for such industry. Current earnings are often depressed in relation to priorearnings.

The stock price has often declined significantly from prior price levels, causing a shrinkage in acompany’s market capitalization.

I can email the full report (53 pages .pdf) for those who want it. Simply email me and ask for it

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Do not read this if easily upset…

We are in a period of forced liquidation, which has happened only eight or nine times in the past 150 years. The fact that it’s historic doesn’t make it any more fun, of course. But it is a pretty interesting time when there is forced selling of everything with no regard for facts or fundamentals at all. Historically, the way you make money in times like these is that you find things where the fundamentals are unimpaired. The fundamentals of GM are impaired. The fundamentals of Citigroup are impaired.

Virtually the only asset class I know where the fundamentals are not impaired – in fact, where they are actually improving – is commodities. Farmers cannot get a loan to buy fertilizer right now. Nobody’s going to get a loan to open a zinc or a lead mine. Meanwhile, every day the supply of commodities shrinks more and more. Nobody can invest in productive capacity, even if he wants to. You’re going to see gigantic shortages developing over the next few years. The inventories of food worldwide are already at the lowest levels they’ve been in 50 years. This may turn into the Great Depression II. But if and when we come out of this, commodities are going to lead the way, just as they did in the 1970s when everything was a disaster and commodities went through the roof.

What I’ve been buying recently is agricultural commodities. I’ve also been buying more Chinese stocks. And I’m buying stocks in Taiwan for the first time in my life. It looks as if there’s finally going to be peace in Taiwan after 60 years, and Taiwanese companies are going to benefit from the long-term growth of China.

I have covered most of my short positions in U.S. stocks, and I’m now selling long-term U.S. government bonds short. That’s the last bubble I can find in the U.S. I cannot imagine why anybody would give money to the U.S. government for 30 years for less than a 4% yield. I certainly wouldn’t. There are going to be gigantic amounts of bonds coming to the market, and inflation will be coming back.

In my view, U.S. stocks are still not attractive. Historically, you buy stocks when they’re yielding 6% and selling at eight times earnings. You sell them when they’re at 22 times earnings and yielding 2%. Right now U.S. stocks are down a lot, but they’re still very expensive by that historical valuation method. The U.S. market is yielding 3% today. For stocks to go to a 6% yield without big dividend increases, the Dow will need to go below 4000. I’m not saying it will fall that far, but it could very well happen. And if it gets that low and I’m still solvent, I hope I’m smart enough to buy a lot. The key in times like these is to stay solvent so you can load up when opportunity comes.

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OIL, Real Estate, Triple, Rogers

– 10 reasons

– real estate

– Triple exposure

– Easy way to follow

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May your 2009 be better than your 2008…

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Retailers, Rich folks, More retail, Jones

– 1/4 gone?

– Spending less

– What to buy then?

– Its stock is cheaper than its product

Disclosure (“none” means no position):
Visit the ValuePlays Bookstore for Great Investing Books

Disclosure (“none” means no position):
Visit the ValuePlays Bookstore for Great Investing Books