Thursday, April 2, 2009

The Marty Whitman Way

I'm not always kind to business journalists, especially some of them on CNBC, so when one does an exceptionally good job, I like to pause and give them their just praise.

Levi Folk, of the Financial Post, wrote a truly excellent piece of business journalism--showing Marty Whitman's strategy by reference to Graham's. It should be read by all, and I'll show why below.

He starts off by accurately summarizing Graham's views on net-nets--"companies whose liquidation values exceed by a wide margin their market capitalizations net of all liabilities." And then he goes on to show how Marty Whitman refines Ben Graham's net-net concept.

First and foremost, companies must be well-financed in keeping with the core tenet of Third Avenue's "safe and cheap" method of value investing...

...The second adjustment is to the assets themselves. Graham and Dodd focused exclusively on current assets when calculating liquidation value whereas Whitman includes long-term assets that are easily liquidated.

...The third adjustment is the inclusion of off-balance-sheet liabilities.

...The fourth and final adjustment to Graham and Dodd is the inclusion of "some property, plant and equipment" for their liquidated cash value and associated tax losses that often produce cash savings.
I edited out the examples given below the adjustments above--which included US banks, Encana Corp, and two long-term holdings of Third Avenue: Henderson Land Development Company and Toyota Industries.

With those examples edited out it is easier to see Whitman's method stripped bare. To understand how it is applied is tougher of course, and that is what the examples in the article allow you to do.

Are you sold that Levi Folk is a business journalist to keep an eye on? You should be. Folk does miss making one point, but it comes after the following few paragraphs--which provide an actionable net-net idea:

Sycamore Networks Inc. (SCMR/NASDAQ) is the most compelling example of a net-net situation in the United States offered up by Lapey.

The telecom equipment company has more cash -- US$935-million in all -- than the total value assessed to it by the market, in light of its US$800-million market capitalization and US$38-million in total liabilities.

...Lapey is also attracted to the one-third of outstanding share ownership by management because it presents an important alignment of their interests with those of Third Avenue, who are by and large passive investors.
The fifth adjustment Whitman and his team make in looking at net-nets (or investments in general) is an inclusion of how all the different interests within and around a company are aligned.

As is made clear in their annual reports, in Whitman's books, and in this recent article at Morninstar, Third Avenue looks to enter positions that are not only cheap (on the above basis) but also one's where they are investing alongside managers with successful long-term track records and aligned interests with stockholders.

Marty Whitman's strategy of investing in what is versus an estimate of what will be has proven to be a very successful one over the years--and has proven particularly successful when stocks are wildly mispriced.

Are they mispriced wildly now? Marty Whitman thinks so but feel free to differ in the comments section below.

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