I often tell clients and investors: “If I can find one or two opportunities a quarter, I’m ecstatic.” As we close out the third quarter of 2009 in a few days, I’d like to share with you some of the investments we’ve made. As I mentioned in this post, I simply don’t have the time to maintain an F Wall Street portfolio, but that doesn’t mean I haven’t been investing!
We’ll start with a position taken on July 27, 2009 – Volt Information Sciences. It’s the company to which I alluded in this article, and then mentioned in this comment. Below is the text of an e-mail I sent to clients shortly after I bought the stock. After the text of the e-mail, I’ll provide some thoughts.
Dear Joe,
Today we invested in Volt Information Sciences Inc. (NYSE: VOL, “Volt”), a provider of staffing services and telecommunications and information solutions throughout the U.S. and Europe. Odds are, you’ve never heard of Volt, and a quick look at the business’ performance might leave you scratching your head over this one; so, let me explain.
Remember: We always want you to be as comfortable with your portfolio as we are.
Volt is a very “ordinary” business – thin profit margins in good times, and a very average return on equity under normal conditions. (Average return on equity for American businesses is around 12%.) Over the past ten years, Volt’s revenues have been steadily increasing and earnings, while volatile, have also risen over time. Still, it’s not the next Google.
What is it about Volt that attracts us? Ben Graham and “net-net.”
Net-net: Defined
A “net” is a stock that is trading for less than its “net liquidation value” – its break-up value. You may also know these as the low “price to book” or “below liquidation value” stocks discussed in many value investing books. A “net-net” is a stock that is trading for less than its “net working capital less long-term liabilities” – basically, a company that has so much in cash, accounts receivable, and other “current assets” that it could pay off all of its liabilities (short- and long-term), and still be liquidated for less than its trading value, assuming its properties, equipment, and other long-term assets were completely worthless.
Ben Graham – the father of value investing – discussed these in both The Intelligent Investor
The math behind net-nets is simple, and we’ll illustrate it with our recent investment in Volt.
Volt as a Net-net
Volt’s market capitalization – the price at which we could theoretically purchase the entire company – is about $163 million. The company reported (May 3, 2009) $633.8 million in current assets, which include cash-on-hand, accounts receivable, inventories, and other cash expected over the next twelve months. The company also reported $61.2 million in property, plants and equipment, and another $111.5 million in various other long-term assets, both tangible and intangible.
The sum of the company’s liabilities, both short- and long-term, was $411.2 million.
Temporarily ignoring the roughly $173 million of long-term assets (properties, goodwill, etc.), the company could quickly be wound up in the next year for $633.8 (current assets) minus $411.2 (total liabilities), or $222.6 million – roughly 25% more than the market capitalization – and that’s assuming that the properties, equipment, and all other long-term assets are totally worthless.
Worth More Dead Than Alive?
If Volt shut down today and liquidated in an orderly fashion, we would likely earn more money – probably 15% or so more – than we paid today. And though the market seems to be pricing Volt as if it’s going out of business, we see no reason that it should.
In its fiscal years ending October 29, 2006 and October 28, 2007, the company’s operations generated more than $33 million of owner earnings. For the fiscal year ended November 2, 2008 – a tough year for all businesses – operations generated nearly $24 million of owner earnings. The first six months of this fiscal year which ended on May 3, 2009, the company had negative owner earnings of -$3.8 million – a small sum when compared to its financial and cash position. Its short-term liabilities are well covered and the company has virtually no long-term debt.
Though its earnings have fallen significantly and turned negative over the past two years, this hasn’t caused a rapid cash burn. Furthermore, the company has recorded $14.4 million in impairment and restructuring costs so far this year – costs that are not likely to occur over a long period of time.
Through the worst part of this recession (the first two quarters of this year; still, I wouldn’t break out the bubbly as anything can and does usually happen), the company’s cash burn rate was such that it could reasonably operate under those extreme conditions for more than ten years.
The Margin of Safety
Our margin of safety on this purchase appears to be two-fold:
- if the company goes out of business, we should get back more than we paid in an orderly liquidation. (Again – we don’t believe there is any risk of it going out of business.)
- if the company returns to a more “normal” state of operations, its intrinsic value should be more than double what we paid.
We plan to exit Volt at the sooner of:
- two years,
- a 100% gain, or
- a material change in the business that would no longer make its then market price attractive.
A Note on Today’s Price Action
If you bring up today’s chart on Volt, you’ll see that it spiked in early trading on no news. That was us, and it speaks to the ridiculousness of the markets and why prices mean very little.
We placed a large order for Volt relative to its regular trading volume. Though the market maker tried to sneak us in, the market’s speculators – seeing the aggressive buying – also jumped in to ride the Volt trend of the day. Ultimately, I expect them to be disappointed as our early, aggressive buying dried up when the order was filled, and now they are sitting on short-term, trend-trading holdings that they will likely dump at any price, causing Volt to drop and forcing them to take a loss.
That is the nature of the day-to-day markets. The actions of one large investor can affect the actions of dozens or hundreds of smaller investors; and, while every approaches the same stocks with different intentions (long-term holdings vs. short-term trading; 2% daily gains vs. 100% multi-year gains), they all act together to create wild volatility and unpredictable daily price changes.
By not taking our cues/instructions from price changes, we can be much more patient in our approach and have results that may not correlate with the overall markets.
As always, if you have any questions, please let us know.
Joe Ponzio
End e-mail
Going Where the Panic Is
In March of this year, I presented to MBA students at Howard University in Washington D.C. I modified Buffett’s “Be greedy when others are fearful” by summing up my investment strategy as:
The time to invest is when you find an asset surrounded by fear, where the risks of that asset are grossly overestimated.
When it comes to investing, the first question you must seek to answer is: What can I lose? It’s not a question that is answered with absolute precision; but, it can be answered to a certain degree. In this case, the market seemed overly fearful of Volt – an employment company in the midst of rising unemployment – and priced it below liquidation value.
What could I lose? If the company were liquidated in an orderly fashion, I’d expect to earn about 15%. If it survived as an ongoing concern, I’d look for a 100% or so gain. As Mohnish Pabrai put it: Heads I win; tails I don’t lose much or win a little. (By the way, Pabrai’s was a great annual meeting; and, though I’ll write about it soon, Miguel Barbosa at Simoleon Sense posted some notes here as well.)
Could I lose in other ways? Sure! The price could have fallen 50% from our purchase price, and then never recovered because the market never went on to realize Volt’s value. The economy could have been brought back to the brink and we could have entered a full-blown depression, wiping out Volt in the process. So…yes – there is always a way to lose money. Still, the key is trying to minimize those risks by investing in companies with:
- an “edge” that virtually ensures higher profits for many years to come, and/or
- a balance sheet with quality assets and manageable liabilities.
Then…you have to pay such an attractive price that the risks of losing money are minimal at best.
They won’t all be like Volt – moving almost straight up from the point of purchase. In fact, more times than not, they’ll be more disappointing than not because you’ll never know when the fear will pass and the party will start. They’ll be volatile; they’ll be ugly. Then again…that’s what makes them so beautifully attractive.
(Why didn’t I buy it at $4 back in March? It wasn’t on my radar!)
Looking Back at Mistakes
It’s always good to go back over past investments and see what worked and what didn’t. If you can sort through your past holdings and ignore the “lucky” ones, you’ll probably begin to find that your mistakes (and my mistakes) led to losses because the companies in which we invested didn’t have a strong enough edge or didn’t offer a solid enough financial base, and we paid too much money for too little quality.
Investing is all about looking into the future; so, it’s impossible to know for certain whether or not today’s purchases will be long-term winners. Still, you’ll be amazed at how much risk you can mitigate and how satisfactory your results will be if you simply focus on paying cheap prices for good assets surrounded by fear, where the risks to those assets are grossly overestimated.
Other Purchases
We also invested in three other companies in this quarter, and I’ll get to those in a future post. Four companies purchased in three months – now you see why I haven’t been around! Thanks for your patience with my absence!
Filed under: Companies Analyzed (Generals)
Related Stocks: VOL
“I often tell clients and investors: “If I can find one or two opportunities a quarter, I’m ecstatic.” As we close out the third quarter of 2009 in a few days, I’d like to share with you some of the investments we’ve made. As I mentioned in this post, I simply don’t have the time to maintain an F Wall Street portfolio, but that doesn’t mean I haven’t been investing!”
I only found one 
I agree with you 100% on how hard a good investment is available, especially after a huge market rally. Yet, I find certain bloggers and professionals talk about bargains all the time. I’m I missing something?
( REPLY )
Francisco: Volt was a 5% to 10% position, depending on the client. Our portfolios typically have between 8 and 20 positions when fully invested; so, I don’t buy stocks at 1% or 2%. If I don’t have enough conviction to put 5% or 10% in, I don’t buy.
I’d sell after two years (depending, of course, on what’s happening at that time) because I don’t expect Volt’s intrinsic value to rise rapidly and I don’t expect the price vs. intrinsic value to widen much based on intrinsic value growth. As such, I would consider walking away if I could find opportunities elsewhere. I also want to set long-term expectations to everyone that it’s a long-term investment…not a trade.
Would I absolutely sell after two calendar years? Ultimately it depends on what’s going on in the business and the margin of safety at the time.
Value Investing: Apparently, you are missing something – the need to trade widly. I saw an article the other day by a “value investor” (not you, of course) that was recommending a stock at $38 with a sell target at $41. To me, that’s nuts. BUT…it’s the only way for him/them to keep readers coming back, to get them to pay for their “premium” content/services, and to stay out in front.
I’d rather buy that same stock at $20 and not buy another stock or write another article for six months!
Anand: I don’t know when I’ll post them, but PLEASE don’t buy the companies I discuss without doing your own thorough analysis…if for no other reason than this: I don’t know if or when I’d be able to write an article after selling the position. Buying stocks is great, but you need to know when to get out as well, and I can’t necessarily offer that here. (That’s why I got rid of the F Wall Street portfolio!)
( REPLY )
Hi Joe
As always I like your clear style of communication.
My question is at a generic level and not specific to Volt. My concern is that in a Graham stock it could turn out that ” Tails I dont lose, but Heads I dont win”.
There could be Graham stocks with ROE lower than cost of capital which could over long periods of time destroy value. So fundamentally it might remain cheap but the market never gets around to unlocking value. The real loss then is the opportunity loss.
Buffett has the advantage to being able to buy a company competely or atleast have significant stake to be able to influence management to unlock value.
One way to look at it is a to build a sub portfolio of graham stocks mechanically and even if the market recognises a few of them and unlocks value the portfolio on a whole could deliver returns.
Would appreciate your view on this.
Cheers
( REPLY )
That was a great post Joe. Thoroughly explaining your process is a great learning tool. My company uses a lot of VOLT employees (I can tell by their different colored badges). However, like you said, many have been laid off as the company tried to keep it’s internal employees. For now they prefer us to use off shore companies like Wipro.
( REPLY )
Joe…
Thanks for the insight into your buying decision on VOL. I trying to trace back your numbers for Owner Earnings I am not able to under stand how you came up with $24m for Owner Earnings fiscal year end November 2, 2008. Via Morningstar I see that Free Cash Flow is at ($96m) for fiscal year end 2008. Can you please explain how you turned that into a positive $24m.
Thanks!
Justin
( REPLY )
Ninad: You make a great point, which is precisely why a thorough analysis is required and why I try to stay away from capital intensive businesses.
Satya: I look in a lot of different places for stocks. 52-week low lists, below book value stocks, etc. This one happened to be in the low price-to-book screen – along with a number of others I looked at.
Jason Linden: That’s partly why I don’t know if I like Volt as a long-term holding, but really liked it as a liquidation/Ben Graham play.
Justin: Free cash flow and owner earnings may be very different, especially in smaller companies. I discuss it in the book and in a number of posts on this site. Volt had a lot of charges that would affect earnings and free cash flow, but that one could eliminate when calculating owner earnings. (One-time, non-recurring, or short-lived expenditures that wouldn’t affect cash flow in the future.)
Graham Jervis: I’ll have to take a close look at them. Perhaps as important as the liquidation value is knowing how much cash the business will burn before things turn around. If the company is bleeding cash, the liquidation value may plummet (and even below the market price), thus killing your margin of safety, intrinsic value, and investment returns.
( REPLY )
Hi Joe,
When you get a chance, can you explain your reasons for getting out of Adobe? Did something change within your analysis, or did you just find better opportunities?
( REPLY )
Joe,
I have been a long-time follower of F Wall Street and loved the book as well. I want to invest intelligently, but I find that I don’t have the time to analyze hundreds of companies every year, or the expertise to dive as deep in to a company as you do.
So a few questions:
1) Have you ever thought of starting a mutual fund for the “little guys” like me that don’t quite meet your investment minimums?
2) If not, what are your thoughts on having an “automated” investment system where we can invest alongside you? Maybe a subscription service or like Greenblatt does?
Basically, do you have a way for us “little guys” to invest intelligently WITH you instead of with HELP from you?
( REPLY )
Noel – I’ve had the same questions. To me, the issue is basically: how can I get a hold of the client letters that explain Joe’s purchases in real time while still compensating Joe appropriately? I wouldn’t mind getting them a day after he has made his moves, because these would not be trading plays dependent on market timing. At the same time, I wouldn’t feel obligated to purchase the stock if I didn’t agree with the reasoning or felt uncomfortable with the investment (which would be seldom, because after all, the whole point is that I don’t have the time or circle of competence to find these values).
More notes from Pabrai Funds Annual Meeting (via GuruFocus): http://www.gurufocus.com/...
( REPLY )
Noel- you don’t need to analyze hundreds of companies a year. Joe has already told you how he narrows his field:
” I look in a lot of different places for stocks. 52-week low lists, below book value stocks, etc. This one (VOL) happened to be in the low price-to-book screen – along with a number of others I looked at.”
You only need a few profitable investments so your first order of buisness should be to find out what kind of companies you want to invest in and use that criteria to narrow your field. When I find a stock, I watch the news feeds about that stock and often find other stocks that peak my interest. If you decide you don’t have enough time to analyze the stocks you invest in, put your money elsewhere.
The “expertise” you’ll need will come with experience. For example, if you decide you like to invest in net/nets you’ll likely realize that they often trade under book value because they are in a deteriorating buisness where investors expect them to continue to operate so that the book value of the company decreases over time. Sometimes the book value is made up of inventory that loses value over time : a company selling blank vhs tapes would find their inventory had more value in the 80s than it does today. The easy part is the number crunching, evaluating the buisness model is the part that gets better with experience.
( REPLY )
Guy’s,
there is also an excel program that uses Joe’s investment process in terms of FCF, it was done by Sanjay Shetty of http://indiainvestor.word... this program has helped me alot along with Joe’s book.
Check it out, hope it helps also. I am not sure if the excel program is endorsed by Joe, but they said it is based on the F Wall Street model
( REPLY )
Hi Joe,
I have a question which would sound pretty basic. You mentioned “Though its earnings have fallen significantly and turned negative over the past two years, this hasn’t caused a rapid cash burn”. How do you calculate the cash burn rate, is it same as the owners earning?
( REPLY )
Hey Joe,
Charlie Munger has said a number of times that in his previous life as an investor he thought if he could just get enough assets for the price he paid, things would turn out all right. He says he later learned the folly in this thinking and shifted his focus to competitive advantage and the strength of the underlying business.
What are your thoughts on this? I’ve been wrestling with this issue myself. DLIA is another stock that is selling cheaply on a quantitative basis, but its in a market that has fierce competition.
And to compound my confusion further, it seems many hardcore buffett/munger followers are ignoring buffett’s advise about getting into great businesses at fair prices than fair businesses at great prices by going into stocks like DLIA.
thanks
( REPLY )
If you have sold VOL, have you purchased it again now that it has dropped again? The net net of VOL reminds me of when you bought and SHRP. SHRP is now nearly bankrupt. How would you get your return on a net net such as SHRP if they do go bankrupt? I imagine if that is the case it would take months to years to get your investment back? How does it generally play out if it all goes south?
( REPLY )
Joe,
Great post. Was wondering if you had taken any action on net-net’s at all. Seems as though a lot of them are gone now. Hopefully we’ll get another bite at the apple.
BTW: have you checked out the Greenbackd blog (www.greenbackd.com) – there’s a ton of good stuff there on net-nets.
Looking forward to more posts.
( REPLY )
Hi, I am confused with the numbers that have been used in your analysis. Looking at the latest 10-Q which is dated on April of 2009, the Current Asset of that period is about 628.2 Million Dollars. The only number close to your 633.8 million current asset is from the 10-Q dated in January of 2009 which was about 633.5 million. Is there a reason for using this number and/or has there been something that I am not taking into account?
Also, regarding the total liabilities, it is shown in the April 2009 10-Q to be that of 428.6 million. Why have you used 411.2 million in your calculation rather than the total liability in the 10-Q?
Thank you very much and I hope to learn something new soon.
-SHM
( REPLY )
As a MarketMinder.com contributor, I often hear this viewpoint. Recently, we published our take on this: http://www.marketminder.c...
( REPLY )
Joe,
How do you feel about this investment given that the company has not released any financials for almost a year now? Is it possible to value VOL currently based on a quarterly report from last May?
( REPLY )
Thanks for the new post. Do you always send out emails to clients after you make a purchase? I think this would be very valuable to clients.
( REPLY )