Graham's Number / The Daily Reckoning

verfasst von - ELLI -, 03.01.2003, 00:28

-->Graham's Number

The Daily Reckoning

Paris, France

Thursday, 2 January 2003

-------------------

*** What did Gary know...and when?

*** Bankruptcies hit records...Hindenburg stocks...

*** Gold up $66 in '02...soft dollar, or gassy
greenback?...Bonne Année, encore...a report on the
feast...and more

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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?

-----------

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...

[Editor's note: If you're interested in following Myers'
resource recommendations for what may continue to be a bull
year for resources, please click on the following link:

The Great Money Flood of 2003
http://www.agora-inc.com/reports/OST/OutstandingGain/

------------

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 PRESENTS: With the Dow down 17% and the
broader indexes faring worse, most stock investors are
happy to bid `good riddance' to 2002. Extreme Value's Dan
Ferris suggests a simple tool for making sure you don't
lose money on stocks in 2003.


GRAHAM'S NUMBER
by Dan Ferris

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.

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.")

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.

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.

Obviously, there's more to Blair than liquid assets like
cash and accounts receivable. But the other parts of the
business only add to it's 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.


Regards,

Dan Ferris,
for The Daily Reckoning

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.

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• Graham's Number / The Daily Reckoning - - ELLI -, 03.01.2003, 00:28