Recently, Berkshire Hathaway CEO Warren Buffett was named the second richest person in the world, second only to his friend Bill Gates, with a net worth of $75 billion. While Buffet is a household name, what many may not know is that he owes much of his philosophy and success to a far less prominent individual.
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Rare is the man that makes it to the top on his own, and Buffett will be the first to tell anyone who will listen that studying under, and working for, the "father of value investing" changed his life. Yes, I am referring to Buffett's mentor Benjamin Graham. Whilemuch of Graham's methods and formulas might not quite work today, it is instructive to see just what the man who taught Buffett everything he knows would be doing in the stock market today. And, who knows, we might just find a few interesting investment candidates as part of our journey.
Image Source:Equim43via Wikimedia Commons.
Who was Benjamin Graham?
Benjamin Graham, originally "Grossbaum", was born in London, England in 1894. His family moved to New York City when he was young, and Graham grew up in Manhattan. As a young man he showed an aptitude for not only the arts (he was fluent in Greek and was also a fantastic dancer) but mathematics, eventually attending Columbia University. It was here that he would begin to make his mark, not only as an academic but as a investor.
Before Graham, investing was entirely speculative. Insider trading was rampant. Rumors flew along with stock prices. Graham sought to eschew all of this. He wanted to be scientific about investing. He sought to buy shares for less than they were reasonably worth to a private investor. The idea was simple, but at the time it was extraordinarily innovative. To people like Warren Buffett, the methodology of value-investing was not only life-changing, but extraordinarily attractive and commonsenseat its base.
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So just what is "Grahamian Value Investing"? Graham, to put it simply, sought to buy a dollar bill for fifty cents. While this strategy, in its implementation, is still a solid mix of art and science, Graham is and should still be credited with bringing a methodology to investing.
Benjamin Graham's formulaic approach to investing evolved over the years. He started out looking for cigarbox stocks selling for less than the value of the underlying assets and what they could be liquidated for in a fire sale, and as this became less and less of an option because of its popularity he shifted to buying shares of companies at low price to earnings ratios.
One could spend an entire day running different screens on the different methodologies that Graham used over the years. The Benjamin Graham who wrote Security Analysis was not the Benjamin Graham who wrote The Intelligent Investor. So, for the sake of argument, and with the full knowledge that it's 2016 and generations of value investors have grown up learning of Graham's methods, let's keep this simple.
Here are the five stocks with market capitalization above $500 million trading for less than half of their tangible book values, which also happen to have been profitable over the last 12 months:
|Company Name||Ticker||Market Capitalization||Price/Tangible Book Value||Net Income [LTM]|
|Atwood Oceanics, Inc.||NYSE:ATW||852.8||0.274||265.3|
|Noble Corporation plc||NYSE:NE||1,571.3||0.246||221.0|
Data source: S&P Global Market Intelligence.
Why are they cheap?
To anyone who has looked wholeheartedly into Graham's methodologies, it quickly becomes apparent that the businesses in question are frequently in trouble. This did not bother Graham, and his solution was to buy a large basket of "cheap" stocks (his portfolio frequently had over 100 stocks in it).
We have some good leads here, but we need to do some vetting:
Costamere (NYSE: CMRE) -- Costamere happens to be one of the larger owners of international container ship vessels in the world. Its fleet of 70 vessels make sure goods and services traverse the seven seas safely and international trade runs smoothly.
Unfortunately, the natural competitiveness of such a commoditized industry has led to questionable balance sheet leverage (it has over $2.5 billion in assets and just under $1.6 billion in liabilities), making this one a likely no-go. This doesn't sound terrible at first glance, but the company's assets are primarily comprised of container ships -- and are thus likely far less than their balance sheet carrying values. Something that would have almost certainly caused Benjamin Graham to become extremely cautious on the name. One becomes all the more confident in this assessment with the news that 12 million shares were sold on the open market in November 2016 at $6 per share for "general corporate purposes and the repayment of debt." This is an obvious sign of desperation, and besides -- nobody likes dilution. Pass.
MBIA Inc. (NYSE: MBI) -- MBIA, a key player in the mortgage and bond insurance market, may not sound too appealing to anyone with memories of the 2008/2009 financial crisis at the forefront of their mind. But make no mistake, it has a lot to offer those who aspire to follow in Benjamin Graham's footsteps.
While shares have been weighed down by worries concerning MBIA's insurance of Puerto Rico's government debt, at just 40% of tangible book value investors are more than protected. It has been estimated that insurance would have to put up $450 million in the event of a Puerto Rican default. MBIA is one of several insurers that are exposed, and boasts some $3.6 billion in tangible equity. It will survive the current turmoil.
MBIA also happens to be trading for a lower price-to-tangible-book ratio than it has in a long time:
This fact, coupled with its record of modest profitability and relatively unleveraged balance sheet ($11.8 billion in assets and $8.1 billion in liabilities as of September 30, 2016), makes MBIA a strong candidate for any Grahamian investor. Candidate.
Transocean (NYSE: RIG) -- Transocean is a victim of the current secular downturn in the oil and gas industry. This is nothing new or unique -- the entire energy sector has had a rough few years. Far more interesting is the fact that, while it has long been known as the owner of one of the oldest offshore drilling rig fleets in the marketplace, this is no longer the case.
Thanks to the exceptional leadership of CEO Jeremy Thigpen, formerly the CFO of industry heavy-weight National Oilwell Varco, its balance sheet and fleet age are quickly improving. Today, for example, offshore drilling bell-weather Noble Corp. PLC has an average fleet age of 14.5 years. If you include newbuilds set to come online in the next few years, Transocean's average age currently sits at 14.3. Thigpen has also managed to bring the company's total debt to assets ratio down from 71.8% as of 12/31/2015 to 53.6% as of 9/30/2016. No small feat given the current operating environment.Candidate.
Atwood Oceanics (NYSE: ATW) -- Atwood Oceanics has long been admired within the offshore driling industry for its young fleet and conservative financial management.
These positives aside, investors should be forewarned: revenue and earnings continue to drop amid the drastic downturn in the sector. Revenue in the company's recent fourth-quarter fiscal year 2016 results fell 40% year-over-year, and profits were practically breakeven at $4.2 million.
Short-term results would not have scared Graham, however, especially were he to get a look at Atwood's balance sheet. As of September 30, 2016 it had $4.5 billion in assets and just $1.23 billion in liabilities. Its current operating environment is less than ideal, but Atwood is highly likely to make it through the current storm. Candidate.
Noble Corporation plc (NYSE: NE)-- as with any other offshore oil drilling contractor, Noble Corp. is doing the best it can to keep on trucking in the current environment. The shares' slide from the mid $40s down to their current $6 position has obviously been painful for shareholders, but for interested investors seeking to follow in the footsteps of the dean of value investing they are certainly worth a look.
Noble holds over 30 rigs to offer customers, which are newer than average compared to those of the company's peers. Current day rates are lower than in previous years (as might be expected with oil still 50% below its highs of 2014), but the company will likely be able to survive. As of September 30, 2016 it had $12.6 billion in assets and $7.76 billion in liabilities -- one could do worse in such a capital intensive industry. At just a quarter of tangible book value, shares are definitely worth a look for value investors.Candidate
Foolish final thoughts
While there are not a plethora of stocks Graham might be interested in on the open market today, it is clear that even eight years into a bull market there are cheap stocks to be found for those looking to follow in his footsteps.
As the quintessential teacher, one who planted trees so that future generations could sit in their shade, nothing would make Benjamin Graham happier than to know investors continue to look for fundamental values amid the speculative noise on Wall Street.
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