Yesterday, I looked at Graham’s caclulation of the intrinsic value of Wright Aeronautical Corporation. Today, I want to look at his example of J.I. Case.
Earnings per share
1932 – ($17.40) loss
1931 – ($2.90) loss
1930 – $11.00
1929 – $20.40
1928 – $26.90
1927 – $26.00
1926 – $23.30
1925 – $15.30
1924 – ($5.90) loss
1923 – ($2.10)
Here is a profile of the company in early 1933:
Share price: $30.00
Earnings: ($17.40) for 1932
Asset value: $176
Graham’s range of intrinsic value: $30 to $130
- Graham thought that J.I. Case was an example of a situation where an analyst cannot reach a reliable estimate of intrinsic value.
- He goes on to say that if the price were low enough, an analyst MIGHT be able to conclude that it was undervalued, for example at $10.00 per share.
- An analyst cannot assume that a regression to the mean will occur or that an average of past earnings will persist. There must be “plausible grounds” to support the analyst’s projection, particularly if it involves growth.
- Some value investors will simply not pay for future growth, on the assumption that no such projection is reliable. Others, such as Buffett, are highly selective and will only invest in a growth company if, in addition to having good growth prospects grounded in facts, it also has a clearly entrenched competitive advantage.
- Some companies should be put in the “too hard” pile. There are plenty of fish in the sea and time is valuable; don’t waste it on trying to figure out the unsolvable.
- Be highly suspect of asset values, particularly of distressed companies. Sellers of newspapers in today’s market are receiving a cruel object lesson in the value of assets that can no longer produce profits. In his 1985 letter to shareholders, Buffett described what happened when he liquidated Berkshire Hathaway’s looms.
“Some investors weight book value heavily in their stock-buying decisions (as I, in my early years, did myself). And some economists and academicians believe replacement values are of considerable importance in calculating an appropriate price level for the stock market as a whole. Those of both persuasions would have received an education at the auction we held in early 1986 to dispose of our textile machinery.
The equipment sold (including some disposed of in the few months prior to the auction) took up about 750,000 square feet of factory space in New Bedford and was eminently usable. It originally cost us about $13 million, including $2 million spent in 1980-84, and had a current book value of $866,000 (after accelerated depreciation). Though no sane management would have made the investment, the equipment could have been replaced new for perhaps $30-$50 million.
Gross proceeds from our sale of this equipment came to $163,122. Allowing for necessary pre- and post-sale costs, our net was less than zero. Relatively modern looms that we bought for $5,000 apiece in 1981 found no takers at $50. We finally sold them for scrap at $26 each, a sum less than removal costs.
Ponder this: the economic goodwill attributable to two paper routes in Buffalo – or a single See’s candy store – considerably exceeds the proceeds we received from this massive collection of tangible assets that not too many years ago, under different competitive conditions, was able to employ over 1,000 people.”
In conclusion, Graham’s notion of intrinsic value is a highly useful concept, if you use it correctly and understand its limitations. As Aristotle said, “It is the mark of an educated man to aim at accuracy in each class of things only so far as the nature of the subject allows.” Be patient and hold your fire until it’s obvious. There have been plenty of these opportunities in the past and there will be plenty in the future.