cigar butts15 Nov 2012 21:49
Warren Buffett: How To Make 50% A Year In Micro Cap Stocks (extract from Gurufocus)
Here’s Walter Schloss on Ben Graham:
“When Ben was operating in the 1930s and 1940s, there were a lot of companies selling below their net working capital. Ben liked these stocks because they were obviously selling for less than they were worth but in most cases, one couldn’t get control of them and so, since they weren’t very profitable, no one wanted them. Most of the companies were controlled by the founders or their relatives and since the 30s was a poor period for business, the stocks remained depressed. What would bring about a change?
1. If the largest controlling stockholder died, the estate may want to sell control.
2. If business got better, then the company would make money.”
Notice Walter doesn’t say anything about liquidation. This is a common myth about Ben Graham and net/nets. Ben Graham did not buy net/nets because he thought they would liquidate. Ben Graham bought net/nets because he knew the businesses were selling for less than they were worth.
This is obvious with a private business.
If you put your private business up for sale, there will be no discussion of prices below the net current assets of the business. Private businesses are not bought and sold below their net current assets. So why should pieces of public businesses be bought and sold below their net current assets?
We can take this analogy further by looking at lenders. For over 2,000 years, it’s been pretty easy to borrow against net current assets. The character of the business owner and the quality and future prospects of the business itself have mattered very little to lenders who knew their loans were covered by cash, receivables, and inventories free of other obligations.
If buyers are willing to pay more than net current assets for almost any business regardless of its quality, and bankers are willing to lend up to net current assets for almost any business regardless of its quality, why shouldn’t investors buy pieces of every business selling below its net current assets?
Mostly, they do. Very, very few businesses sell for less than their net current assets. Almost all net/nets are micro caps.
Some people assume that means that there’s something peculiar about net/nets.
They’ve got it backwards. There’s something peculiar about micro caps.
Small stocks tend to be undervalued more often than large stocks.
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