Liquidation Value Investing

[melveyr]

A share of common stock is a slice of an underlying business. The fundamental value of the business can be very ambiguous, but there are some rough estimates that can tell us when valuations are insanely cheap.

Benjamin Graham pioneered a quick and dirty way to find out the fundamental "floor" value of a business in the context of a fire sale. You simply look at the balance sheet and:

Add 1 * Cash
Add 1 * Short Term Investments
Add 1 * Long Term Investments
Add 0.75 * Accounts Receivable
Add 0.5 * Inventory
Subtract 1* Total Liabilities

The value arrived at is a very rough but conservative estimate of what the pieces of the firm would go for in a fire sale. Note that we excluded fixed assets! The accounting is messier for them and excluding them entirely makes our estimates much more conservative. Let's call the value arrived at the "liquidation value."

Next you take the market value of equity and divide it by the "liquidation value." Lower is better. If the number is 0.60 than you are essentially paying 60 cents for a dollar of assets.

I wrote a Python script that scans balance sheets for every US stock from Yahoo! Finance and publishes the companies with the best liquidation ratios here:
http://liquidationvalue.blogspot.com/

I am still messing with the site so if you check back and something looks weird, I am probably fiddling with the code. Regardless, I think it is going to be a very fun VP experience that will help me stay sharp with my accounting/finance skills (I am going into corporate finance when I graduate) as well as potentially finding some good bargains occasionally.

Right now, Emerson Radio is the most compelling company on the list for me. They have a product that is very easy to understand (I can visualize what the inventory is) and they have paid out special dividends in the past, so the catalyst for value realization is there.

If anyone else finds this concept interesting we can pick apart some of these names together and find some bargains. A lot of the companies that end up on this screener are small and unwatched by large institutions, so the potentially for superior analysis on our part is there.

[Storm]

Incredible!  Ryan, you continue to amaze me.  A really astute VP investor could just invest $500 in each of these companies and most likely see insane profits in the next 12-24 months!

What is it about Emerson Radio that appeals to you more than, say, Sycamore Networks?

[melveyr]

Glad you like it Storm! This is a really fun part of the market so I am excited to try and master it. You are picking up the pieces of broken dreams.

My script simply gets the values from the latest balance sheet. The last balance sheet for SCMR is dated October 26, 2012. Since that time they have paid $4.50 in special dividends. Because these payments happened after October 26 they are not reflected in my formula. To see the special dividends you can look at a chart using google finance. What is cool about SCMR is that they are actually in the process of liquidating. Management says shareholders can expect around $2.60 a share. It's cool that the screener indicates that it would make sense to liquidate and some of the companies on the list are actually doing it. Shareholder capitalism in action.

The main thing that draws me to Emerson Radio (MSN) is that they have positive EPS. Lot's of these companies just burn through their cash but Emerson has the potential to slowly wind down their business in a profitable fashion. They just lost a big contract with Walmart, but I think they will still be able to scrape by. I just need them to not do anything incredibly stupid and throw me a couple of big dividends. Management is sketchy, but the rock bottom valuation helps me feel a little better.

This list is really something to watch over the long term. I included companies that are trading at ratios up to 2.0 so that I can get familiar with names as they reel in, then I can pounce on them more confidently.

[k9]

TYVM melveyr ! My VP actually consists in those deep value stocks, so that's very interesting for me. I'm actually more digging into european cigar butts (to reduce taxes & fees a LOT), but I'm still interested in US bargains too.

Deep value is supposed to give better results than average but with much higher volatility and on a much bigger time frame (get ready to underperform the market by 10% a few years in a row, get ready to stomach -50% from time to time, etc.), so I think that is one of the best choices for a VP.

And, you're right, that's fun to buy stocks that are so cheap that you only pay for the cash & investments and get real estate, inventories and even the underlying business for free. And telling friends you bought shares of a small company specialized in cardboard wrapping when they are all talking about buying glamour stocks like apple or sony is very funny

[melveyr]

TYVM melveyr ! My VP actually consists in those deep value stocks, so that's very interesting for me. I'm actually more digging into european cigar butts (to reduce taxes & fees a LOT), but I'm still interested in US bargains too.

Oh wow. I bet a lot of great cigar butt opportunities happened with all of the financial scares happening in Europe.

[annieB]

That's too cool!

[melveyr]

Interesting... HLYS ( the maker of kids shoes with little pop out wheels) is getting taken over at almost exactly the "back of the napkin" liquidation amount! Ol Benjamin Graham was a smart one.

[k9]

TYVM melveyr ! My VP actually consists in those deep value stocks, so that's very interesting for me. I'm actually more digging into european cigar butts (to reduce taxes & fees a LOT), but I'm still interested in US bargains too.

Oh wow. I bet a lot of great cigar butt opportunities happened with all of the financial scares happening in Europe.

Quite so. All the more easier to find as I have no liquidity criteria. I have lines no bigger than 500 $ so I can really buy forgotten nano-caps nobody seems to care about for less than the net cash they hold and with a dividend yield close to 10%

That Ben Graham was really wise...

[melveyr]

TYVM melveyr ! My VP actually consists in those deep value stocks, so that's very interesting for me. I'm actually more digging into european cigar butts (to reduce taxes & fees a LOT), but I'm still interested in US bargains too.

Oh wow. I bet a lot of great cigar butt opportunities happened with all of the financial scares happening in Europe.

Quite so. All the more easier to find as I have no liquidity criteria. I have lines no bigger than 500 $ so I can really buy forgotten nano-caps nobody seems to care about for less than the net cash they hold and with a dividend yield close to 10%

That Ben Graham was really wise...

Anything you especially look out for?

I am staying away from firms where the liquidation value has been going down over time. For example IGOI is a no go for me:


Where as MSN (Emerson) has been preserving and increasing its liquidation value:


Are there huge values you have found that are not reflected on the balance sheet? How did you identify them?

[MediumTex]

How does RIMM look under this analysis?

[melveyr]

My application of Graham's technique gives RIMM a liquidation value of 1.8B and it is trading at 6.6B.

It is important to note that RIMM probably has a lot of patents and technology related assets that are not fully reflected on the balance sheet. Graham's technique works best for companies where the going rate for the underlying assets is very unambiguous, allowing you to buy with confidence. I am not an expert on tech patents but I imagine a realistic liquidation value for RIMM is higher than 1.8B, but I don't have the skills to know exactly where.

For my own foray into deep value investing I am going to focus on very simple widget makers where I can literally visualize the assets that I am buying at a discount.

[MediumTex]

How about Sears and Six Flags?

They both seem like liquidation candidates in the next 5-10 years.

[melveyr]

MT,
The back of the napkin approach to ballpark it is simply doing current assets minus total liabilities. For SHLD and SIX this is negative. Remember, we are interested in the common shares which are last in line in the capital structure. Again, this approach ignores real estate but we are really interested in forming a conservative estimate so using only the liquid assets in our measurements is prudent.

[MachineGhost]

Right now, Emerson Radio is the most compelling company on the list for me. They have a product that is very easy to understand (I can visualize what the inventory is) and they have paid out special dividends in the past, so the catalyst for value realization is there.

I think you're talking about Graham's Net Liquidation Value (NLV)?  The problem with NLV is it identifies very few stocks or none at all during bull markets.  Remember, 1942 was the valuation low for the post-Great Depression when Graham and Dodd came out with their manifestos.  Buffett and Greenblatt have further refined the NLV.

MSN is a consistent dog that has been a penny stock for at least ten years now.  I have seen it pop up many times on value screens.  It never leaves.

Value alone is dangerous.  You have to account for a lot of other metrics to weed out the fat tails that will destroy a portfolio, especially in a secular bear market.

[melveyr]

I think you're talking about Graham's Net Liquidation Value (NLV)?  The problem with NLV is it identifies very few stocks or none at all during bull markets.  Remember, 1942 was the valuation low for the post-Great Depression when Graham and Dodd came out with their manifestos.  Buffett and Greenblatt have further refined the NLV.

I am not relying on this strategy for the core of my portfolio (that is still the PP). I can afford to be very selective or potentially have zero invested in this strategy from time to time. I just want to be ready if/when the market crashes with a full shopping list that I can confidently purchase.

MSN is a consistent dog that has been a penny stock for at least ten years now.  I have seen it pop up many times on value screens.  It never leaves.

Value alone is dangerous.  You have to account for a lot of other metrics to weed out the fat tails that will destroy a portfolio, especially in a secular bear market.

Value traps can be very dangerous I agree. But Emerson has paid out  special dividends during the past 4 years. I think the catalyst for value realization is there. Also, I have no delusions about some huge comeback in clock radios. I just think that I am buying assets for a discount. I have a limit order to sell my shares at $2.60.

[k9]

Anything you especially look out for?
[...]
Are there huge values you have found that are not reflected on the balance sheet? How did you identify them?

I'm mostly basing myself on automated techniques, because I don't want emotions to interfere with me. That's the hardest part with value investing, by far. So I only base myself on the balance sheet & buy most of the stocks that sell at or below 80% NCAV, or 2/3 tangible PB if there are not enough NCAV.

I don't spend too much time in selecting stocks as these are very small lines I'm investing in. It's not worth spending hours ans hours examining every detail for so small amounts. This is a probability game, but this time I'm on the casino side, so by buying enough stocks (25) I should win, on average. If I can't find 25 stocks that meet my criterion, but only, say, 20, I'll buy these 20 stocks for 1/25 of my capital each and keep 5/25 of the money in cash. If I have more than 25 available, I manually choose which ones I'll buy.

I wait until the price rose 50% or 2 years have passed and then reexamine the situation, for each stock. If it still meets my criteria, I keep it for another +50% or 2 years. If not (NCAV went down or price went up but there is no safety margin left), or if it looks like a value trap (no consideration of shareholders), I sell.

I think you're talking about Graham's Net Liquidation Value (NLV)?  The problem with NLV is it identifies very few stocks or none at all during bull markets.  Remember, 1942 was the valuation low for the post-Great Depression when Graham and Dodd came out with their manifestos.  Buffett and Greenblatt have further refined the NLV.

The point is, when you can't find enough, you just keep some cash aside waiting for the opportunities. That's the hard part with this strategy : you aren't invested at all during bull markets. That's why I wouldn't advise it as the main strategy in a portfolio, but that makes it a good VP alternative.

[melveyr]

I don't spend too much time in selecting stocks as these are very small lines I'm investing in. It's not worth spending hours ans hours examining every detail for so small amounts. This is a probability game, but this time I'm on the casino side, so by buying enough stocks (25) I should win, on average. If I can't find 25 stocks that meet my criterion, but only, say, 20, I'll buy these 20 stocks for 1/25 of my capital each and keep 5/25 of the money in cash. If I have more than 25 available, I manually choose which ones I'll buy.

I thought of a very similar system before you posted that. It makes a ton of sense because it forces you to diversify when there are lots of opportunities, and stay out when there are none. Good stuff.

[MediumTex]

Right now, Emerson Radio is the most compelling company on the list for me. They have a product that is very easy to understand (I can visualize what the inventory is) and they have paid out special dividends in the past, so the catalyst for value realization is there.

I think you're talking about Graham's Net Liquidation Value (NLV)?  The problem with NLV is it identifies very few stocks or none at all during bull markets.  Remember, 1942 was the valuation low for the post-Great Depression when Graham and Dodd came out with their manifestos.  Buffett and Greenblatt have further refined the NLV.

MSN is a consistent dog that has been a penny stock for at least ten years now.  I have seen it pop up many times on value screens.  It never leaves.

Value alone is dangerous.  You have to account for a lot of other metrics to weed out the fat tails that will destroy a portfolio, especially in a secular bear market.

Believe it or not, over 20 years ago I had a broker who was pushing Emerson based upon a value screen.

I bought in and of course I lost money on it.

BTW, I was about the same age back then as melveyr is today, and it is staggering to me how much more he knows than I did when I was his age, and I am speaking more about the psychological aspects of investing than the technical aspects.

[MachineGhost]

BTW, I was about the same age back then as melveyr is today, and it is staggering to me how much more he knows than I did when I was his age, and I am speaking more about the psychological aspects of investing than the technical aspects.

Long live the Internet!

[Reub]

And he's not even old enough to be President!

[melveyr]

Thanks for the kind words everyone, but let's get down to business!

Anyone want to help me research IOT? I think they are sitting on a bunch of land. It looks cheap as hell. If these guys ever sold some land and paid a dividend this stock could triple. I think this is a situation where as long as management isn't a total fraud and you are patient enough you have a good margin of safety on a fundamental basis.

Edit: I am seeing a lot of related party transactions... this one will probably forever just be a piece of paper.

[Xan]

melveyr, I'm curious about the insider ownership percentage.  You must think it's important since it's on your spreadsheet.  What do you think is the optimum value and why?  This is an intriguing idea and I'm looking forward to seeing how it plays out.

[melveyr]

I think the sweet spot is 5 - 40%.

If management owns too much of the company than they can treat the firm like their personal piggy bank. It is difficult for shareholders to overthrow the management if management owns 51% of the company. I want the possibility for a corporate raider to come in and unlock value for shareholders.

However, too little is obviously not good either. If they don't own any shares than the share price just becomes a squiggly line as far as they are concerned.

Another great thing to check for though is if the "insiders" are actually just big outsiders (like a hedge fund). If so, then this is extremely positive because these hedge funds can really push for shareholders.

[melveyr]

Here is a humorous overview of the strategy compliments of Danny Devito in Other People's Money:
https://www.youtube.com/watch?v=yypj-aYtp9c

[MachineGhost]

EMAN is another dog that's been in the dumps for 15+ years.  They have alot of patents for OLED display technology, but can never seem to perform.  Similarly for DRIV.

Then we have the former momentum high flyers: CREE is unlikely to ever recover to its Internet bubble days.  Same for CROCS which was a temporary shoe fad.  SMSI was when PC faxing was all the rage.  MRVL. JOSB. SKX.

Other failures I recognize: LBTR, IMN, HTH, PWER, Z, ARTC, ADI, SKX.

It makes me wonder: what characteristics signify these kind of below-par companies so one can avoid them?  So I think just buying indiscriminately is as stupid as thinking we know what's going to outperform just because we think we understand the fundamentals.

It looks like all of these companies are in different life cycle stages.  Just looking at the list, I would invest heavily in biotech because that is a regular boom/bust cycle that is currently booming again.  Or alternatively, invest in those growth companies that are undervalued.  What really matters in making money in the stock market is where the hot money is flowing to or away from.  Everything else is mental masturbation.