In Benjamin Grahams book: The Intelligent Investor (more specifically, in chapter 7) he supposes some strategies for the defensive and enterprising investor. One of them comes under the title of "bargain issues" which are defined as companies selling below net current assets after accounting for long-term debt as well. The argument for this is to protect your principal (the initial money invested.) If you can find companies trading at below or near liquidation value, downside risk is reduced significantly. Even better, finding companies trading at less than net current assets means you get the fixed assets (PPE and the like) plus any goodwill for free. You get the going concern, free. Even better, because you're not including fixed assets, the subject of whether the assets on the balance sheet reflect their true "replacement value" is mitigated so there's no need to do adjustments ;). Cash of $100 is cash of $100, simple (if you want to learn more about accounting adjustments in practice have a look at Bruce Greenwalds book - Value Investing: From Graham to Buffett and Beyond.) Warren Buffett began doing this in the 50s and made a killing from it. Markets since then have become more efficient but not always. He recently bought South Korean companies that were trading at less than working capital (a typical "net-net" investment as it's called within the value investing literature.)
Well, what if the company defaults you may ask. Because you're subtracting all the liabilities and you also have non-current assets and intangibles on top, you can liquidate and get your principal back (in America you'd also have to subtract preferred stock from the equation, however, this isn't a big issue in Australia as it essentially doesn't exist here.) Sounds like a safe bet to me. I try explaining this type of investing as buying a farm for $5,000 but the farm has $10,000 sitting in the middle of it.
You see, Benjamin Graham was a very interesting man, at a time of financial mayhem and everyone asking the question "how much can i make" he turned the question on it's head and asked "how much can i lose?" (this is my interpretation of his work, but if you look at his 1934 preface of Security Analysis i believe it's not unreasonable to suggest what i am suggesting.) He then went out and formally detailed how you do that. He not only created a style of investing, he created a profession: the financial analyst.
The company that I've put an order in for (yet to reach my price) is Mount Gibson Iron (ASX: MGX). The problem with deep value investing (companies selling at least a 30% discount to firm value) is that you need a well diversified portfolio of them to do it successfully. Sometimes, the companies shares go to $0 and you lose everything. However, it's not all doom and gloom. This style of investing is one of the best if not the best in terms of shareholder returns. Another thing to note is that this type of investing is definitely not for everyone. The kinds of companies you focus on tend to have major problems at the moment, so iron ore companies may be a good place to start your search. Moreover, not only are they having problems but by nature, it's contrarian investing which means you tend to also be buying against the crowd.
Yes, i jumped around a lot, but i had a lot of things running through my head and i wanted to get them all out.
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