One Minute Summary:
This chapter is about using current asset value as an approximation of a company’s liquidation value—book value of current assets should be adjusted to reflect liquidation value. Companies that are selling under liquidation value usually demonstrated unsatisfactory earnings trend, which may continue to operate at a loss and nullify the intrinsic value to below price paid. As a result, the analyst should examine companies that have reasonable basis of earning improvement based on past records and future prospects.
This chapter is about using current asset value as an approximation of a company’s liquidation value—book value of current assets should be adjusted to reflect liquidation value. Companies that are selling under liquidation value usually demonstrated unsatisfactory earnings trend, which may continue to operate at a loss and nullify the intrinsic value to below price paid. As a result, the analyst should examine companies that have reasonable basis of earning improvement based on past records and future prospects.
New terminology / Concepts / Ideas / Technical Items / Useful Examples:
• During liquidation, non-current assets are to experience the most shrinkage; thus, as a safety measure, current asset value provides a rough measure of the liquidating value.
• History may serve as an indication of future. In the chart, Manhattan Shirt would likely to yield better results since its net current asset was reduced by 10% during a very difficult period, compared to 60% of Hupp Motor.
Additional comments:
• Liquidating/market value for real estate, buildings, machinery, equipment, nonmarketable investments, intangibles, etc are more easily obtainable today. If the analyst is confidence about his/her source of information, the percentage of liquidating value to book value can be adjusted higher than what is suggested by the chapter.
• During liquidation, non-current assets are to experience the most shrinkage; thus, as a safety measure, current asset value provides a rough measure of the liquidating value.
• History may serve as an indication of future. In the chart, Manhattan Shirt would likely to yield better results since its net current asset was reduced by 10% during a very difficult period, compared to 60% of Hupp Motor.
Additional comments:
• Liquidating/market value for real estate, buildings, machinery, equipment, nonmarketable investments, intangibles, etc are more easily obtainable today. If the analyst is confidence about his/her source of information, the percentage of liquidating value to book value can be adjusted higher than what is suggested by the chapter.
Practical Application:
• Past history of a bargain issue should be examined to determine whether an investment in such issue will yield satisfactory results in the future.
• To be considered as an attractive investment, these bargains must have potential catalysts in either improvement in future earnings, potential sale or merger, or liquidation distribution.
• Past history of a bargain issue should be examined to determine whether an investment in such issue will yield satisfactory results in the future.
• To be considered as an attractive investment, these bargains must have potential catalysts in either improvement in future earnings, potential sale or merger, or liquidation distribution.
Three Quotes:
1. “Common stocks that (1) are selling below their liquid-asset value, (2) are apparently in no danger of dissipating these assets, and (3) have formerly shown a large earning power on the market price, may be said truthfully to constitute a class of investment bargains.” Pp. 570
2. “…voluntary withdrawal from an unprofitable business, accompanied by the careful liquidation of the assets, is an infinitely more frequent happening among private than among publicly owned concerns.” Pp. 559
3. “Dividends paid to common-stock holders do not in themselves make the stock any safer. The directors are merely running over to the stockholders part of their own property; if the money were left in the treasury, it would still be the stockholder’s property.” Pp. 573
1. “Common stocks that (1) are selling below their liquid-asset value, (2) are apparently in no danger of dissipating these assets, and (3) have formerly shown a large earning power on the market price, may be said truthfully to constitute a class of investment bargains.” Pp. 570
2. “…voluntary withdrawal from an unprofitable business, accompanied by the careful liquidation of the assets, is an infinitely more frequent happening among private than among publicly owned concerns.” Pp. 559
3. “Dividends paid to common-stock holders do not in themselves make the stock any safer. The directors are merely running over to the stockholders part of their own property; if the money were left in the treasury, it would still be the stockholder’s property.” Pp. 573
Three questions to the group to test understanding:
1. What kind of liabilities may be off balance sheet?
2. How would you go about to confirm the book value of current assets on the balance sheet?
3. How would you value the capitalization structure when the debt instruments (preferred or fixed coupon debts that have a convertible feature into common stocks)?
1. What kind of liabilities may be off balance sheet?
2. How would you go about to confirm the book value of current assets on the balance sheet?
3. How would you value the capitalization structure when the debt instruments (preferred or fixed coupon debts that have a convertible feature into common stocks)?
Clarifications & Group Discussion:
1. Case study of Bennett Environmental Inc.
2. What essences should we take away from this chapter since the “net-nets” are less obvious in today’s market?
3. Today, some businesses may have their intangible assets understated. Would you consider “mark-up” the value of these assets? If yes, how would you assess the value, and should the intangibles be considered as a current asset?
4. Would you apply similar discount percentage to the book value for different asset classes suggested by the chapter?
1. Case study of Bennett Environmental Inc.
2. What essences should we take away from this chapter since the “net-nets” are less obvious in today’s market?
3. Today, some businesses may have their intangible assets understated. Would you consider “mark-up” the value of these assets? If yes, how would you assess the value, and should the intangibles be considered as a current asset?
4. Would you apply similar discount percentage to the book value for different asset classes suggested by the chapter?
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