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Grahamian Value Week in Review ― November 27, 2020
“The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”
— Warren Buffett, July 4, 1999
In the past week —
No new businesses have been added to the list of Grahamian Value companies.
There were no interesting developments at Grahamian Value listed companies to explore.
BRIEF OVERVIEW —
With no new activity to address this week, below we share two timeless readings.
I. TIMELESS READINGS
Warren E. Buffett: The Security I Like Best; Oil & Gas Property Management, Inc.
As published in The Commercial and Financial Chronicle on January 17, 1957, Warren Buffett details his investment thesis for Oil & Gas Property Management, Inc. —
(Co-editors’ note: Buffett Associates, Ltd launched on May 1, 1956)
A more fitting title for my selection would be “The Inflation Hedge I Like Best.” Should inflation continue [Oil & Gas Property Management, Inc.] may well be the vehicle to give the investor the same super-charged performance that highly leveraged investment trusts and warrants did in the early 1940’s.
O & G was organized in 1952 by interests affiliated with the Empire Trust to buy and manage producing oil and gas properties. The management is of the highest caliber and the Empire’s reputation and experience in oil matters has undoubtedly been of considerable value. Purchases have been made subject to to substantial oil payments with a large portion of income in the early years used to extinguish these payments. This method might be compared to real estate purchased subject to large mortgages with rental income, exclusive of that portion needed for operating expenses, utilized for mortgage reduction. The tax laws facilitate this method very considerably when applied to oil by allowing all payments as a direct exclusion from income. Accounting-wise, the result is to show a very small gross income while the equity is being built up substantially. Accordingly, the financial services do not show accurately the operating picture of O & G and the interested reader should study the annual reports of the company.
The equity money for O & G was originally raised by the sale of $10 million income debentures with 300,000 shares of stock attached. The issue was exceptionally well placed in large blocks with Wall Street houses, investment trusts, etc. The underwriting fee on the sale amounted to about 1/4 of 1%. An additional 80,000 shares of the common were sold to the promoting group with the Empire Trust reputedly owning over 50,000 shares in a subsidiary. Large issues of warrants and options are conspicuous by their absence.
The equity money of O & G was invested by the end of 1954. Thus the company has acquired its properties on a somewhat more reasonable basis than might be expected at current higher prices for oil in the ground.
The table below shows the substantial reserves of the company and illustrates the dynamic possibilities of the small issue of common stock even should no increase in oil and gas prices occur. Figures are based on the 1955 annual report and we understand there has been little change since that date.
The net reserves for stock and debentures reflect the reduction from gross reserves of amounts sufficient to retire oil payments and loans. The debentures are income bonds and are not expected to pay their interest (which cumulates) until most of the oil payments have been liquidated. Accordingly, it may be estimated that approximately $15 million will be required to retire the debentures with interest. Operating expenses of course must be deducted from the gross values in the last column of the table and in the case of plant products, which represent half the oil reserves, will be more than average. Allowing $35 million for operating expenses and possible taxes still leaves a potential for the common of $40 million. Future acquisitions could increase this substantially.
The 280,000 shares of common have a total market value of about $5 million which makes the arithmetic of the picture fascinating. An increase in the price of oil 15 cents per barrel or 1 cent per MCF in the case of gas is equal to the entire market value of the common. If oil over the next few years were to increase in price 50 cents per barrel, the gain in value would be equal to almost 400% of the current total market price of the common.
At the end of 1955 the company had about $49 million of oil payments and about $17 million of loans and debentures ahead of the 380,000 shares of common. However, over $33 million of the payments is applicable to one property and it is important to note that payments are obligations of only the specific property, not the company. The balance of payments amounted to less than $16 million and were reduced by $4 million in 1955 alone. Currently the average payout on these is probably less than three years away.
It is interesting to compare O & G with its more well-producing counterpart — Producing Properties, Inc. This company also started with about $10 million of equity capital although it didn’t get under way until early 1955. At a recent date PP’s production was running about 2,200 barrels per day against over 7,000 for O & G and their net reserves were also less than a third those of O & G. On the other hand, they had invested only about half of their equity money so it is not to be implied that they were doing a poorer job of investing the money — it is just that they got off to a later start. However, PP common is selling in the market for about $14 million and, in our opinion, represents less value and potential than is present in O & G selling for $5 million. If O & G were to command only the same valuation, it would mean a price of over $35 per share.
O & G also owns a half interest in Yemen Development Corp. which holds a concession on two-thirds of Yemen covering 40,000 square miles including a large basin area. Geological reports are favorable although Suez unrest will undoubtedly delay testing this area. Offsetting this plus potential in the picture is a minus potential in that the largest property of O & G is involved in litigation concerning gas prices. O & G’s position has been upheld by the FPC; however, the matter is now before the courts.
O & G common, selling around $14 in the Over-the-Counter Market, should do very well if present oil prices are maintained and presents outstanding possibilities should inflation continue. Behind $65 million of obligations with an estimated gross value of oil and gas offsetting these obligations of $150 million, the $5 million market valuation on the common seems to offer considerably higher chances for gain than for loss. A small investment in O & G should do the job that a many times larger investment in a non-leveraged oil holding would do while exposing the holder to a much smaller maximum loss.
Oil & Gas Property Management’s market capitalization was approximately $46 million in 2020 dollars.
As observed last week, John Malone maintains: “We’ve survived this [pandemic] because of enormous fiscal and monetary stimulus, and I’ve got to believe this will lead to devaluation of currencies; that hard assets ... will increase in value in currency terms.” (Week in Review — November 20, 2020)
You Can Be a Stock Market Genius: Outlined Case Examples
Joel Greenblatt’s investment examples within You Can Be a Stock Market Genius are similarly timeless; one case illustration —
Restructuring Example #1: Greenman Brothers
Greenman Brothers is a marginally profitable distributor of toys, housewares, and stationery.
Stock just above $5, book value of over $8.
Most assets were in cash, receivables, and recently purchased inventory that could be readily sold.
Huge upside – Did not seem that market is giving any value to the new Noodle Kidoodle. The upside, if successful, can be huge.
Limited downside – If the assets of the distribution business sold for $6 (assuming a 25% haircut on book value of $8), you still get the Noodle Kidoodle business for free.
Catalyst – If Noodle Kidoodle is to grow, it needs funds. Funds can be obtained either by borrowing or by selling the distribution business.
Business available to restructure – The distribution business.
How it played out
Bought before May 1994.
Stock traded between $4 to $7.
Noodle Kidoodle stores did well, and distribution business did worse.
May 1995, Greenman announced the possible sale of its distribution business and free up capital to grow Noodle Kidoodle.
Stock moved up to $11 in 2 months and $14 within 4 months.
Greenblatt sold between $10-$11.
Noodle Kidoodle was later bought over by Zany Brainy for $4.50 in April 2000.
Co-editors’ note: Abridged financial statements appear on page 7 of Form S-1 filed with the Securities and Exchange Commission on December 14, 1995
Combined International & Ryan Insurance Group (1982)
Harcourt Brace Jovanovich & Florida Cypress Gardens (1985)
FMC Corporation (1986)
Super Rite Foods (1989)
Liberty Media (1990)
Charter Medical Corporation (1992)
General Dynamics (1992)
Home Shopping Network (1992)
Wells Fargo (1992)
Marriott Corporation (1993)
Paramount Communications & Viacom (1993)
American Express (1994)
Briggs & Stratton (1994)
Greenman Brothers (1994)
II. WEEKEND WATCHING
Courtesy of Bloomberg Quicktake: “The David Rubenstein Show: Peer-to-Peer Conversations” explores successful leadership through the personal and professional choices of the most influential people in business. Renowned financier and philanthropist David Rubenstein travels the country talking to leaders to uncover their stories and their path to success. The third episode features Berkshire Hathaway Chairman and Chief Executive Officer Warren Buffett. (Recorded November 2, 2016)
Courtesy of Talks at Google: Jeremy Miller, author of Warren Buffett’s Ground Rules: Words of Wisdom from the Partnership Letters of the World's Greatest Investor, reflects on Mr. Buffett’s partnership letters and his early investing style. (Recorded September 2016)
Courtesy of the Wharton School of Business at the University of Pennsylvania: Howard Marks, Co-Chairman of Oaktree Capital Management, talks with Chris Geczy, Adjunct Full Professor of Finance. They focus on Marks’ memo, “Coming into Focus,” regarding his economic forecast for a post-pandemic recovery. He answers pre-recorded questions from students and audience-submitted questions, following opening remarks by Wharton School Dean Erika James. (Recorded November 18, 2020)
III. WEEKEND LISTENING
Courtesy of Capital Allocators, hosted by Ted Seides (twitter): Common Sense for Value at Gotham Capital — Joel Greenblatt is a legendary value investor, founder of Gotham Capital, longtime teacher at Columbia Business School, and author of four investment books, the latest of which, Common Sense: The Investors’ Guide to Equality, Opportunity, and Growth recently hit the bookstands. Our conversation takes a tour through Joel’s career. We cover his background, early success running a concentrated portfolio, closing of the fund to manage his own money, and re-opening with a more diversified approach. We discuss Joel’s timeless investment beliefs and along the way also discuss the Value Investors Club, seeding managers, and applying investment lessons to education. (November 23, 2020 episode date)
Courtesy of Invest Like the Best, hosted by Patrick O’Shaughnessy (twitter): Jason Zweig, The Power of Serendipity — In this episode, Jason Zweig and I discuss investing, financial advice, books, and life in general. The method for living discussed in the last 30 minutes will be useful for everyone. Jason is the Intelligent Investor columnist for the Wall Street Journal and author of several books, including his latest, the excellent “The Devil’s Financial Dictionary.” His insights and advice are the results a life of critical thinking, reading, writing, humility, and curiosity. (September 27, 2016 episode date)
Courtesy of Masters in Business, hosted by Barry Ritholtz (twitter): Ed Thorp, The Man Who Beat the Dealer and The Market — Barry Ritholtz interviews Ed Thorp, one of the most storied people in finance. A math professor at MIT and UC Irvine, Thorp figured out how to beat Las Vegas at blackjack and baccarat, created statistical arbitrage, and ran a hedge fund that not only beat the market by a wide margin, but never had a losing quarter. He is the author of several books, including “Beat the Dealer” and “Beat the Market”; his latest book is “A Man for All Markets.” Thorp tells Ritholtz that the secret to beating the market is having an edge that's specific, definable and mathematical. If you don't, you should be in index funds instead. This interview aired on Bloomberg Radio. (July 14, 2017 episode date)
Courtesy of The Tim Ferriss Show, hosted by Tim Ferriss (twitter): Inside the Mind of the Iconic Writer — Michael Lewis is the best-selling author of many books, including Liar’s Poker, Moneyball, The Blind Side, The Big Short, The Undoing Project, and The Fifth Risk. He lives in Berkeley, California, with his wife and three children. (May 1, 2020 episode date)
ABOUT GRAHAMIAN VALUE
Grahamian Value is a labor of love, centered around our desire to openly share data and perspectives that we find helpful in our pursuit of Benjamin Graham-inspired investment ideas. We appreciate your time, your trust and your readership. Learn more at GrahamianValue.com
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Harry Sauers and Shai Dardashti are co-editors of Grahamian Value and, as of the date of this communication, may individually own shares of companies mentioned herein. The publishers do not receive compensation from the companies and people covered in Grahamian Value for such coverage. This communication is for informational purposes only. This is not intended to be investment advice. Seek a duly licensed professional for investment advice.