Security Analysis Series: Chapter 43 Summary

“Significance of the Current-Asset Value”

Chapter Summary

  • Current asset value is a good metric in determining the true liquidation value of a company, particularly as compared to book value, which includes illiquid, difficult to appraise fixed assets. Stocks that sell below their liquidating value is “fundamentally illogical”. Error is being committed by the market, company management, or shareholders of the company, or a combination of the above. (pg 559).
    • Stocks typically trade at a price well above liquidating value. Those trading below are called “net-nets”.
  • To calculate liquidation value, liabilities are generally not questioned, but asset values must be. The value ascribed to assets varies on their character, and the nature of the business. Graham prescribes the following approximate percentages to book value in finding liquidation value: (pg 560).
    • Cash assets = 100% of book value;
    • Receivables = 80%;
    • Inventories = 66%;
    • Fixed assets = 1-50%, varying on their nature;
  • Generally speaking, the reduction from current asset value to liquidation value of current assets is made up for by non-current assets, hence the assertion that current asset value is an accurate depiction of liquidation value. (pg 562).
  • In 1932, Graham believed that approximately 40% of American industrial companies were quoted at less than their net current asset value! (pg 562).
  • If a company is trading below liquidating value, either the price is too low, or the company ought to be liquidated. (pg 563).
    • Focusing on these types of companies is a particularly attractive technique in security analysis, and one applied by Graham frequently.
    • The objection to this strategy is that there is a possibility that earnings will continue to decline, and the value of remaining resources dissipated.
      • Graham’s counter-argument is that the range of developments that can occur generally tend to favour higher price movements. This can include liquidation, sale/merger (which generate at minimum a return of liquidating value), general industry improvements, favourable changes in company operating policy, etc. (pg 564).
  • While on the whole this strategy offers profitable opportunities, due diligence is absolutely still required to find signs that liquidation value is rapidly decreasing. (pg 569).
    • Caution should also be exercised when applying this technique to markets that are generally over-valued. An ensuing market decline has potential to wipe out much of the current asset values of companies that don’t comprise wholly of cash. (pg 571).

Chapter Thoughts and Analysis

  • While certainly rare in current times, net-nets still doubtlessly exist. There are companies out there right now that even trade at a discount to cash in various commodity industries, though they are likely to be junior or medium sized companies. It is simply a matter of finding the industries that are trading on a depressed basis, where market sentiment is aggressively low.
  • The net-net technique is often regarded as the crux strategy of value-investing by the general public. And the shrinkage of net-net opportunities might very well be the cause of value-investing’s disregard by most investors. But I think Graham would take issue with those who only know value-investing for that technique alone. It is an entire philosophy, rather than a cheap and quick investing gimmick.
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