NetNetNumber:Implications&Conclusions

ByTheodorTonca
Chairman&CEO,GrahamTheodor&Co.Ltd.
Contact:
13380108Ave.Suite1802
Surrey,B.C.V3T0E7
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NetNetNumber:Implications&Conclusions
Perhapsonecouldevendeterminewhetherthemarketlevelwas
gettingtoohighortoolowbycountingthenumberofissuessellingbelowworkingcapital
value.BenjaminGraham
1
Mostareawareofmodernmarketvaluationindicatorsincludethetrailing,medianP/Eratio,Qratio
(marketpricerelativetoreplacementcost)andthedividendpriceratioamongothers.Leavingtheutility
oftheseleadingindicatorsaside,thereisamethodwhichremainsaltogetherignoredand
underappreciatedbythevastmajorityofmarketparticipantstoday.Thatis,thenumberofnetnets
(companiesvaluedbelowtheirnetworkingcapitalminusallliabilities,ignoringthepropertyandother
assetscompletely)presentatanygiventimeondomesticUSmarkets.
Themodestobjectiveofthispaperistopresenttheimplicationsofthisoftoverlookedindicatorrelative
tomarketover/undervaluationasawholeinthepast(19292011)andtherefromhelpdraw
conclusionsastoitsultimateutilityinthepresent.
Keywords
NetNets,NetNetWorkingCapital,NetNetCurrentAsset,MarketValuationIndicator,Market
ValuationMeasure,Predictability,Uncertainty,BenjaminGraham
Introduction
MypartnerandIatGrahamTheodor&Co.remainskepticalofacademicstudiesrelatingtothefieldof
investingprimarilybecausesuchstudieshaveinthepastresultedinthebirthofvarioustheorieswhich
webelievehavelittlerelevanceontheactualpracticeofcapitalallocation.Withthatsaid,therealways
remainsanexceptiontomosteveryruleandinthiscasewhatIamhopefulthisbriefessaywillequateto
thatrarity,ausefulstudy.
WhileIamnotshyaboutrevealingmypredilectionandpersonalbiastowardsalongfavoredmarket
valuationmetric,oneWarrenBuffettoncedescribedasprobablythebestsinglemeasureofwhere
valuationsstandatanygivenmoment
2
,thatbeingtheTotalMarketCap(Asrepresentedbythe
Wilshire5000TotalMarketIndex)ascomparedtotheUnitedStatesGrossNationalProduct(GNP).
Ihaveincreasinglyfoundmyselflookingtoanother,secondarymeasurewhichihavefoundtobeof
someuseandwhichisthesubjectofthispaperbutfirst,somegroundrules.
Totheuninitiated,thetermNetNet
3
coinedbythelate,greatBenjaminGraham,referstoatypical,
operatingbusinesswhichthemarketinastrokeofgeniushasdecidedtopricebelowthevalueofits
currentassets(cashandequivalents,accountsreceivable,etc.)lessallliabilities(accountspayable,
notesincludinglongdateddebt)alone.
Withthatestablished,belowaresomeadditionalconsiderationswhichwillhelponedeciphertheresults
presentedbelow:
NumberofNetNets(NNNgoingforward)allinclusive,entailsallcompaniesvaluedbelownet
currentassetslesstotalliabilitiesinanygivenperiod,notincludingforeignreversemerger
entities,butincludingnonoperatingbusinesses(definedasfalsepositives).
Sincetheactualnumberofprevailingnetnetsinanygivenperiodcanonlybeapproximated
(preciseyearlydatadoesnotexistunfortunately)wetaketheniceroundfigureof100(100+)
tomeananoverallprevalenceofnetnetsinanygivenperiod.
Justthesame,aperiodconsideredtobelackinginprevailingnetnetsmeanstheoverallnumber
fallsunder100(100)inanygivenperiod.
ThemarketbenchmarkusedistheS&P500index,whichshouldsufficeasabroadenough
measureindicativeofthedomesticUSequitiesmarketasawhole.
Results
ExhibitI.
Period NNN S&P500Return
19291950 100+ 5.6%
19511970 100 12.10%
19711991 100 11.89%
19922011 100+ 7.81%
NNN:NumberofNetNetsavg.perannumrounded
S&P500Return:Avg.perannumduringindicatedperiod
Reasons&Implications
Forbetterandworse,BenjaminGrahambothlivedthroughandsurvivedtheGoldenAgeofwhathas
cometobedescribedasValueInvesting.Itwastrulytheworstoftimes(economically)andsomeof
thebestoftimes(forallocatingcapital)withtheNNNestimatedatover200individualissuesatone
timein1931
4
,orfullyoneineverythreecompanieslistedontheNewYorkStockExchangewere
availableforlessthantheirnetquickassetsalone,includingoneofAmericaslargestretailers(atthe
time)TheGreatAtlantic&PacificTeaCompanybetterknownasA&Ptoday
5
.
Overfiftyofthesecompanieswereavailablefortrulyfiresaleprices,sellingforlessthanthecashand
marketablesecuritiesontheirbooksalone
6
.
Now,undoubtedlyareasonforthelargecontrastbetweenthelowprevailingmarketpricesduringthis
period(193037)incomparisonwithliquidassetscanbeaccountedforbytheenormousfloodofnew
cashwhichstockholderspouredintothetreasuriesoftheircorporationsupontheexerciseoftheir
subscriptionrightsinprecedingyears.ToquoteMr.Grahamdirectly:
Thisphenomenon,whichwasoneofthedistinguishingfeaturesofthe19281929bullmarket,
hadtwoquiteoppositeconsequences.Ontheonehandtheadditionalfundsreceivedgreatly
improvedthecompanies'cashandtheirworkingcapitalpositionontheotherhandthe
additionalsharesissuedgreatlyincreasedthesupplyofstocks,weakenedtheirtechnicalposition,
andintensifiedtheirmarketdecline.Thesamecircumstance,therefore,servedbothtoimprove
thevaluesbehindastockandtodepresstheprice.
7
Thesharp193738recession
8
andthedownturnof1949
9
mayalsohavebeencontributingfactorsto
varyingdegrees.
Butcanthesamereasonsjustnotedbeextendedandappliedtosubsequentdecades?Inshort,no.The
subscriptionrightconversionphenomenawasonestrictlyconfinedtotheformerperiodaswasthe
generalmarketdeclineduringtheinceptionoftheGreatDepressionofover89%,fromDowJones
IndustrialAveragepeakof381.17onSeptember3,1929totroughof41.22onJuly8,1932thelow
pointofthe20thcentury
10
.
Whilethegeneralmarketlevelretainsitsprimacyaschiefcontributortoeithertheprevalenceor
shallownessintheprevailingNNN,asevidencedbyourempiricaldata.Adistantsecondaryfactormay
comeintheformoftheretailinvestorandmorepreciselythelevelofhisorherparticipationinthe
equitiesmarket.
Inthisrespect,itisinterestingtonotethattheNNNasawholepredominantlydeclined(100)during
thetwentyyearperiodbetween19501970,aperiodinwhichUShouseholdequityownership
exceeded80%,justshyoftheapprox.92%alltimehighof1945
11
andonewhichwascharacterizedby
theriseofthemutualfundindustrytoover$48billionintotalassetsbytheyear1970
12
,adevelopment
initselfnodoubtpropelledbythehooplaandhysteriasurroundingthesocalledNiftyFifty(termused
torefertoapopularcompositeof50largecapcompanieslistedontheNYSEduringthisperiod)
whichdidnthitafeverpitchuntillaterinthe1960s,butwhichnonethelesscontributedtohelping
launchthebullmarketinequitiesinearnest.
Thisdictumalsoappliestosubsequentintervals,namelytheequityfrenzyof19952000.Asixyear
stretchwhichsawUSdomesticequityfundscollectapproximately$655billioninabsoluteterms
13
.A
recordstillasyetunmatched.Theyear1995alsobeingthelastyearinwhichequityownershipamong
retailinvestorsexceeded50%
14
.
Inmorerecenttimes(20082011)therecordconcerningsuchmeasuresismuchlessconclusive.With
theNNNseenrisingwhileequityownershipamonghouseholdshasdeclinedonthewhole,under35%
asrecentlyas2011beforeincreasingeversoslightlytoapproximately37%morerecentlyin2012.
Likewise,theUSequitymarketdeflatedtojust63%thesizeoffixedincomeandmoneymarketfunds
uptoSeptember2012,reflectingthenetequityfundoutflowswhichpersistedandculminatedwiththe
recordredemptionsseenlastyearof$115billion
15
.
Theserecentfindingsrendersuchanalogousmeasuresinconclusiveatbest.Theonlyconstantor
positivewhichhaspersistedthroughoutallperiodshassolemnlyremainedtheinverserelationship
betweentheNNNandtheequitymarketasawhole,representedbyabroadindexsuchastheS&P
500.
Nevertheless,whatremainsthelogicalconclusionsandimplicationsofsuchfindingsinthepresent?
Conclusion
Aspreviousstudieshaveshown,thesoundnessofimplementinganetnetinvestmentstrategyhasnever
beenindoubtatleastnottothisauthor.
ExhibitII.
However,whatwehaveattemptedtogivetreatmentandprimaryconsiderationtointhisparticular
studyiswhethernetnetscanbeofevenfurtherservicetotheinvestor,asaprimaryorsecondary
marketlevelindicatorinadditiontoinvestmenttechnique.
Inthisregard,ibelievethedatasuggestsaresoundingyes.Willtheempiricalpastextrapolateitselfinto
thefuture?Onlytimewilltell,whatwecanbecertainofinthepresentisthatthisremainsauseful
measureasevidencedbydatafromthemostrecenttwentyfourmonthperiod.TheNNNlistedon
domesticUSexchangeswasapproximately142onDec.1,2011
16
.Asofthetimeofthiswritingon
Aug.1,2013orsometwentymonthslater,thissameNNNhasdwindleddowntounderseventy
companiesindicatingadropofmorethan52%inthisnumber
17
.
Meanwhileourmarketindicator,theS&P500indexhasrisenby21.79%duringthissametimeframe
thuscontinuingtheinversecorrelationbetweenthesetwosetsoffigures.
______________________________________________________________________________
1.BenjaminGrahamCurrentProblemsinSecurityAnalysisNewYorkInstituteofFinanceSept.1946Feb.1947
transcript.SeeJanetLowe,TheRediscoveredBenjaminGraham:SelectedWritingsofTheWallStreetLegendNew
York:Wiley,1999.
2.CarolLoomisWarrenBuffettontheStockMarketFortuneMagazine,December10,2001.
3.BenjaminGraham&DavidDoddSecurityAnalysis:Classic1934EditionNewYork:McGrawHill,1934.
4.BenjaminGrahamThingsIRememberaspublishedinSeymourChatmanBenjaminGraham:Memoirsofthe
DeanofWallStreetNewYork:McGrawHill,1996.
5.MarcLevinsonTheGreatA&PandtheStruggleforSmallBusinessinAmericaNewYork:Hill&Wang,2011.
6.Ibid.,4.
7.Ibid.,4.
8.KennethD.RooseTheRecessionof193738Chicago:TheJournalofPoliticalEconomy,Vol.56,1948.
9.JosephFord&VincentMaherTheRecessionof19481949:TheMostImportantOneofAll?California:National
SocialSciencesJournal,Vol.35Issue1,2010.
10.TheWallStreetJournalDowJonesIndustrialAverageAllTimeLargestOneDayGains&LossesRetrieved
August14,2013.
11.BusinessWeekTheChangingFaceofU.S.EquityOwnershipNewYork:July3,2012.
12.MatthewP.FinkTheRiseofMutualFunds:AnInsidersViewNewYork:OxfordUniversityPress,2008.
13.KevinMcDevittBondFundsDreamsofthe90sChicago:Morningstar,May302012.
14.Ibid.,11.
15.GreggoryWarrenActiveEquityOutflows&FixedIncomeInflowsMark2012Chicago:Morningstar,Dec.26,
2012.
16.GeoffGannonHowManyNetNetsAreThere?Texas:GuruFocus,Dec.2,2011.
17.TheGrahamInvestor:NCAVStockScreenRetrievedAugust14,2013,