Any ‘Grahamian' stock bargains?

Date: Jan 2010
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"Here's how to mine for potential from securities.." V.Krishnaraj

Benjamin Graham, popularly known as the Father of Security Analysis, enumerates many ways of investing for an “enterprising” investor in his book The Intelligent Investor. One such is to buy bargain issues of various types. Graham defines a bargain issue as one “which, on the basis of facts established by analysis, appears to be worth considerably more than what it is selling for.”

A sensible approach to establishing a bargain, as suggested by Graham, is to anchor value around the company's realisable assets after settlement of all liabilities. He laid emphasis on net current assets as there is greater protection in its value than fixed assets, latter being open to wider fluctuations from its value. So, a stock quoting at below net current assets is a clear bargain as the fixed assets and earnings generated would then be for free. While such opportunities are plenty when the stock markets are quite depressed Graham posited that bargains exist at all market levels.

But can one find “Grahamian” bargains in these markets? There is little doubt that the Indian stock market levels are high. Nifty is priced at close to 23 times last annual earnings and pays a paltry 1 per cent dividend income. In comparison, the 10-year GOI securities yield 7.3 per cent annually with the best protection available for a Rupee principal. Let us examine a few securities and test them for bargains.

Bargain hunting

Take, for instance, the case of Bimetal Bearings Ltd (NSE: BIMETAL), which is a 44-year-old firm supplying bearings, bushings and washers to four-wheeler manufacturers. With 38,25,000 shares outstanding, the firm earned Rs. 7.3 crore in FY 09 from a revenue of over Rs. 129 crore. It has little debt and had no losses in the past 20 years.

More than 75 per cent of its assets are either current or investments in various entities and little over 20 per cent of these assets are needed to settle all obligations — current and long term liabilities, provisions and deferred tax liabilities. That leaves about 55 per cent in the hands of share owners or about Rs. 220 for every share. This could be called net current asset value. At Rs. 198 per share on November 30, Bimetal was at a 10 per cent discount to its net current asset value. Had you bought the stock then, you would have got the remaining net current assets and all fixed assets at nil value, in addition to all the future net earnings generated by these assets.

Testing for quality of bargain

However a sceptical investor may rightly want to examine the quality of this bargain or fixed assets for that matter. Rightly so, as why else would any seller quote such a low price for the stock! Let us examine the constituents of net current assets in greater detail. A further break-up of inventories reveals that the firm is carrying under a month's partly and fully finished products and about two-and-a-half months of raw materials. It is highly unlikely that these would suffer any significant loss in value in three months. Sundry debtors pertain to contractual amounts due; but past records suggest almost all are likely to get collected within six months. A large portion of loans and advances pertains to Inter Corporate Deposits. It is thus safe to conclude that the current assets are unlikely to suffer any loss in value.

Investments, generally carried at cost while providing for any permanent loss of value. As an aside, one striking feature is the wide nature of investments. There are no less than 200 entities that have found funds from BBL. The spread of instruments is remarkably wide and even includes gold ETFs and a global real-estate fund! Further the amounts invested vary from as small as Rs. 3,575 to over a crore. Without questioning the underlying logic for such an eclectic mix we notice that a large portion has been placed in fixed income related instruments.

The value of these investments on November 30 at quoted market prices for equity or equity based funds and at book for the rest stood at Rs. 33.4 crore. Even if we impair the equity component of these investments by about 30 per cent (for purposes of safety, carrying them at the same earnings yield as the govt securities), the investments are valued at Rs. 28.9 crore, about the same as on books on March 31 2009.

In sum we see that BBL was selling at 10 per cent discount to its net current asset value, and hence the balance portion of current assets, all of fixed assets and future earnings (at least Rs. 10 per share earned for two quarters this year) were available for free. Further, notes to accounts also do not indicate any serious contingent liabilities.

While not getting into the exact reason of why the share was selling so low, what's noticeable is that it mostly supports Graham's thesis that just as some shares enjoy very high interest some can suffer protracted neglect, creating a potential source of undervaluation and hence an opportunity for the bargain hunter.

Other bargains

Similar bargains were available in other stocks such MRO-TEK, which makes communication equipment, and PNB Gilts, a dealer in government securities. Both the stocks were quoting below net current assets on November 30, 2009.