Graham's Number

It amazes me how often otherwise urbane, experienced and generally sophisticated individuals will say something like, “…but I’d rather just win the lottery.”

Last week, my own mother (yes…it’s true…) sent me a raffle ticket as a small holiday gift. I’d rather she just burned the $5 bill she spent on the ticket. That at least would reduce the supply of money, and therefore help stem the never-ebbing tide of inflation. But alas, that fiver is still out there, having been flushed down the toilet of negative expectation. (If you do the math, you’ll find that you can expect to lose 50 cents for every dollar you invest in lotteries during your life. Blackjack tables offer better odds.)

But there it is. The American Financial Ideal: to spend $1 and make $50 million. That’s what everybody seems to want. It’s as if, the worse things get, the greedier people become.

Go figure.

Blair Corporation: Adieu to 2002

Most stock investors – with the exception perhaps of a few penny goldmine investors (who I might add are in for a bit of a gamble themselves) – are happy to bid adieu to 2002. Corporate scandal has made it all but impossible to trust the numbers you see coming out of Wall Street’s brokerage firms.

The year 2002 saw 5 of the 10 largest bankruptcies in history – totaling more than $368 billion in assets. Of the top ten largest bankruptcies for the year, nine were the result of accounting ‘irregularities.’ And it’s possible we haven’t seen the worst of it yet. “I don’t think we’re going to see any dip in bankruptcy filings,” Alan Field, a bankruptcy attorney in Los Angeles, told Reuters. “I think it’s going to get worse before it gets better.”

Historically, accounting frauds and schemes mount following stock market bubbles…this much is true. But as an investment advisor, it’s hard for me to simply throw in the towel. In fact, for those investors who’ve got the stomach for it, extreme values abound in this market. But, to do so you had better be prepared to familiarize yourself with a corporate balance sheet…and right quick.

To wit, the characteristics of an ideal investment (from the point of view of the investor, rather than your friendly neighborhood broker). Back to the basics, as they say. You’re investment wants to fall into line with one of the following categories, preferably all:

1. The Right Price: At the right price, you’ll receive a return high enough to outperform other investment alternatives, as well as inflation.

2. Complete safety: No concern that any part of the investment could ever be permanently lost…or misrepresented by the accounting department.

3. Always liquid: The ability to redeem the investment for cash at any time of the night or day, every day of the year, without fear of penalty.

4. No income taxes: No income taxes due on the investment growth; you keep all the profit.

5. Total passivity: No special skill or knowledge would be required to make the investment. No active management would be required. One could just forget about the investment and enjoy life. (The true origin of the phrase: “buy and hold.”)

Blair Corporation: A Pipe Dream

Naturally, we never expect these five financial planets to align perfectly. They’re guidelines. Finding an investment that fits all these criteria is practically a pipe dream, in any environment, let alone today’s bankruptcy heightened one. “Perfect safety,” is obviously not something we expect to find anywhere on this earth.

Still, the concept of a perfect investment is not a new one. It has been encapsulated in a long-forgotten “indicator”…something I call “Graham’s number.” The number was pioneered and made famous by Benjamin Graham, the father of modern investment analysis, hence the name. Graham, a renowned `value’ investor, has fallen out of favor by some accounts over the last few years; his name all but unheard of in `momentum’ investor circles.

Yet, Graham’s number is easy to find. Just look at a recent balance sheet of any business. Subtract all liabilities – short and long term – from current assets. The resulting number is called net working capital, or net current asset value.

Most of the time Graham’s number is negative. But when it’s a positive number, it means that a company could pay off all its debts and obligations and still have liquid assets like cash left over.

Blair Corporation: A near “perfect” investment

Not many companies can make that claim. But, by way of illustration, I’d like to take a look at one. A recent example of a near “perfect” investment I’ve been looking at is the publicly traded Blair Corporation, seller of men’s and women’s clothing through catalogs and its websites.

Blair has been in the catalog business 90 years. In all that time, it has never suffered an annual loss. If you can get a business that never takes an annual loss at the right price, you’ve got an investment you’re likely to want to hold onto for decades.

A key value indicator recently signaled that Blair was selling at the right price. Fewer still are businesses like Blair, whose stock recently traded below Graham’s number. You could have bought the entire company for less than the value of its most liquid assets.

On its most recent balance sheet, Blair reported $275 million in current assets. These are assets that are expected to turn into cash in 12 months or less. Blair reported total liabilities, including long term and short term debt and preferred stock, of $77 million.

Using our simple formula: $275 mil – $77 mil = $198 million. That’s $198 million worth of cash and other liquid assets, which Blair’s shareholders own free and clear, totally unencumbered by any debts or other liabilities.

When I first starting looking into Blair back in September, it was trading for a total market price of about $170 million. If you bought Blair Corporation at that price, you paid 12% less than the value of the company’s free and clear liquid assets. Buying Blair at that time was like paying 88 cents for every dollar of asset value.

Blair Corporation: Adding to Its Attractiveness

Obviously, there’s more to Blair than liquid assets like cash and accounts receivable. But the other parts of the business only add to its attractiveness. For example, Blair also owns buildings and equipment, which it uses to conduct its business. Those long-term assets have value, and provide a return for investors. Buying Blair when its market cap was at $170 million got you a piece of its long term assets – over $50 million worth – free! When I can get the assets of a thriving business for free, I know I have a generous margin of safety. I know I’ve paid the right price.

Using Graham’s number to determine the right price for Blair Corporation’s stock became a short cut to our five- pointed investment lodestar: a good price (promising a high return); the safety of underpriced assets; the liquidity of publicly-traded equity; the tax efficiency of a buy-and- hold investment in a company with a 90-year profit history; and an investment that is safe enough to “set and forget.”

Since we first wrote about Blair Corporation in September 2002, Blair has produced total returns (including dividends) in excess of 20%. Most stocks lost that much or more in 2002. Most investors will never see another 20% a year in their lives.


Dan Ferris,
for The Daily Reckoning
January 2, 2003

P.S. In 1988, a DePaul University professor named Joseph Vu wanted to find out how effective Graham’s number was at finding profitable investments.

In his research, Professor Vu assumed that a stock would be bought when its price dipped below Graham’s number (like Blair) and sold two years later. Professor Vu’s research results showed that buying stocks that sold for less than Graham’s number and holding them for two years produced average annual returns of just over 24% a year. If we use Professor Vu’s 24% rate of return for stocks selling below Graham’s number – as Blair did recently – $10,000 will turn into more than $15,000 in two years. Even when the broader market indicators are signaling a rough ride.


We still can’t quite believe the year is over – but good riddance. You may recall, dear reader, that when the going was still pretty good – in May 2001 – Global Crossing CEO Garry Winnick sold $123 million of his own stock. Then, the bad news came out it began to look as though Winnick had known something that the Moms & Pops and Widows & Orphans didn’t.

No way, Winnick protested; how was he to know that the company had more than $12 billion in debt it couldn’t pay? He was as surprised as the patsies.

But here it is 2003…and can you believe it…Winnick says he’s leaving. Imagine the loss to the company! Winnick’s knowledge of the undersea cable business began and ended when he once watched a video showing how cable was laid underwater. That was all he needed to know. His real business was convincing investors to send him money. And now, when the company really needs someone who knows about working underwater, off he goes!

Global Crossing, you may recall, was technology hallucinary George Gilder’s favorite stock. Well…who didn’t like it in May of ’99? The stock was trading at $64. Who would have imagined that had he waited a couple of years – until the company went into Chapter 11 – he could have bought all he wanted for just 2 cents a share?

But that’s life in America’s collectivized patsy stock market of 2003. The little guys still believe that if they buy Wall Street’s products at Wall Street’s prices – somehow, they’ll get rich. They’ve heard the advertising…that stocks allow you to ‘put your money to work.’ That ‘nothing beats investing in stocks for the long run.’

They’ve heard that capitalists make money…and think they can make money, too, by pretending to be Warren Buffett. Good luck to them!

The patsies have to be separated from their money somehow, we suppose. And Wall Street does a pretty good job of it.

But…a trio of executives over at Conseco did a pretty good job of it too, says a Bloomberg report. Stephen Hilbert took home $457 million in pay and perks over 7 years…as the shareholders lost 90% of their investment and the stock fell into the $5 range.

Then, celebrity CEO Gary Wendt took over. Working “without pay” for 2 years, Wendt managed to get $128 million from the shareholders’ pockets into his own…and put the company into Chapter 11. Today, dear reader, the shares are available for 4 cents.

And so, to preview our guesses about what will happen in 2003, we offer some advice. If you feel like buying a stock, wait; you may be able to get it for a lot less a year from now.



Eric Fry from New York…

– The final trading day of 2002 was mercifully uneventful. The Dow Jones Industrial Average gained a meager 8 points to 8,341, and the S&P 500 index rose less than a point to 880 – or only about 35% below Abby Cohen’s year-end price target of 1,363. Undaunted, the paid-to-be-bullish strategist predicts a gain of 30% for the S&P 500 in 2003…Does anyone really care?

– The annual parade of strategists’ predictions has devolved into a mock-heroic farce. The strategists play their part by taking their predictions – and themselves – very seriously, which enhances the comedic effect of the farce.

– However, the effect is much less comedic for those gullible souls who, over the last three years, may have trusted in the strategists’ woefully errant forecasts. Recall that at the very start of 2002, Abby Cohen urged investors into the stock market with her confident assurances that share prices would rise briskly. Heeding the call, many bullish investors, armed only with their naïve enthusiasm, rushed into the fray and went head-to- head with bearish financial market trends…The outcome wasn’t pretty.

– Now that the gruesome 2002 campaign is finally over, it’s time survey the battlefield and tally up the casualties of this financial Little Big Horn. For starters, the Dow fell 17%, the S&P 500 tumbled 24% and the Nasdaq collapsed 32%. Only 3 out of 30 Dow stocks ended the year with a gain. And as widely reported, the blue chips dropped for the third straight year – the first time this has happened since 1939-41, back when Alan Greenspan was but a mere lad, day- dreaming about the spectacular bubble he would create some six decades hence.

– The carnage in the semiconductor sector was particularly horrifying to behold. The Philadelphia SOX Index tumbled 44%, as all 17 stocks in the index declined. Intel, the iconic leader of the SOX Index, collapsed nearly 50% during the year. Will the technology sector’s woes never end?

– Iraq is said to be preparing a “scorched earth” strategy in the event of war with the US. Saddam and his cohorts could probably learn a thing or two from the blackened landscape of the tech sector, where the new economy bubble did not merely deflate, but burst into a hideous ball of flames, Hindenburg-style. The tech industry is still trying to recover from excess capacity and feeble demand. The recovery might take a while longer, Abby Cohen’s optimism notwithstanding.

– Another notable casualty of the 2002 campaign was the U.S. dollar, which fell a whopping 18% against the euro. Our friends in the Daily Reckoning HQ over there in Paris must now spend $1.047 to buy one euro, compared to only 88.9 cents this time last year. (Ouch.)

– There were some winners in 2002 of course, just not many of them. The most notable winner of the year was an investment that is near and dear to the hearts of most Daily Reckoning readers…Yes, that’s right, the yellow dog finally had its day.

– Gold capped a spectacular year by gaining $4.40 to $347.80 on the final trading day – that’s a hefty $66 higher than where it traded at the beginning of 2002. Gold’s sparkling rally inspired an even more sparkling rally in gold stocks. The Amex Gold Bugs Index more than doubled during the year, and many individual stocks fared even better. Gold-stock mutual funds captured all ten of the top-10 best-performing mutual fund slots, according to Morningstar…Not bad for a “barbarous relic.”

– Our own John Myers capitalized often on the strongly performing gold stocks and on the impressive strength of many other commodities. He racked up some splendid gains this year, both in his investment letter, “Outstanding Investments,” and in his trading service, the “Resource Trader Alert.” One of John’s truly “outstanding investments” was Harmony Gold Mining, which gained 158% in 2002, and is up a plump 207% since John recommended it to his subscribers in late 2001.

– “The weakening dollar and continued global tension will keep pushing commodity prices higher for a long time to come,” says Myers, looking for good times ahead in the resource sector. “As you celebrate the passing of the old year and the beginning of the new – get ready…because we’re going to make it one to remember!”

– Two days ago your co-editor (that would be me) suggested, “If you’re looking to sip some elegant champagne this evening – perhaps some Dom Perignon or Crystal – you might try to wangle an invite to a New Year’s Eve party thrown by a gold-bug.”

– Although written in jest, your co-editor found himself in precisely this happy situation on the evening of December 31st. My good friend Michael Martin, a stockbroker who specializes in gold stocks (who also conducts a lot of short-selling on behalf of several hedge funds, just to keep himself balanced), invited our family over to his house on New Year’s Eve. From the moment we arrived, the pricey champagne started flowing. Michael treated those of us lucky enough to attend to a dazzling array of superb champagnes, including of superb 1993 Dom Perignon…

– Coincidentally, 1993 was also a “vintage year” in the gold sector. As gold stock investors may fondly recall, the gold price jumped that year from $330 an ounce to more then $400 and ounce, while the XAU Index of gold stocks nearly doubled. If John Myers’ bullish expectations for the resource sector are on target, I expect Michael Martin will be serving Dom Perignon again next New Year’s Eve, too…


Back in Paris…

*** Corporate bankruptcies broke records in 2002. Chapter 11 welcomed 186 companies…with assets of $386 billion. Filings included 5 of the largest Chapter 11 cases in history.

*** Automakers say they see no recovery until 2005, reports the Financial Times.

*** “Foreclosures Soar,” says the Rocky Mountain News.

*** Jeremy Seigel, writing in the Wall Street Journal, says he thinks a softer dollar will be good for the economy. It will make it easier for businesses to raise prices and boost profits, he believes.

We’re still looking for the surprise. The dollar’s 18% fall so far seems to surprise no one – and certainly not us. What if it were to fall another 18%…or 50%? What if it were not to soften, but to turn to mush…soup…liquid…or gas? Tune into tomorrow for our guesses about what will happen in 2003.

*** Our family New Year’s celebration was as dull as Maria feared. Elizabeth had tarted up the table and cooked a good meal. The guests were charming and lively. But the family didn’t dive into its Bonne Année feast until after 11. By then, the children and their father were so cranky from fatigue and starvation they couldn’t enjoy it.

The Daily Reckoning