Stocks trading at discounts to their net current assets often look cheap. But investors fear what the the company is going to do with its capital. Companies often trade at such large discounts when they have made poor acquisitions or can't control expenses relative to revenues. But what happens if a company trading at such a discount buys back its shares at the discounted price? Such a company offers the potential for great returns for shareholders.

Consider Alco Stores (ALCS), formerly Duckwall-Alco, a company that has been previously discussed on this site as a potential value play. For months now, the company has been hinting that repurchases may start again, but yesterday their intentions were formalized. The company has entered into an agreement for an investment bank to repurchase shares on its behalf.

Several factors make this a positive for investors. First, as already mentioned, the stock is cheap relative to the balance sheet. The discount to net current assets is about 60% here, even though the company is not burning through cash. As such, book value and net current assets per share can only increase with buybacks.

Second, the transparency regarding pricing is fantastic. The company will buy back shares at up to $9.99 per share (shares currently trade at $6 and change). I don't know why more companies don't do this; it helps shareholders understand exactly how their capital will be allocated. Warren Buffett does it with his company, as he recently let it be known that he would start to buy back shares if they fell below 1.1x book value. Jewett-Cameron (JCTCF) is another one of those rare companies that was transparent in this regard, and subsequently executed a buyback that increased its share price considerably.

Finally, this is not a token buyback. Though the number of shares to be repurchased represents just under 5% of outstanding shares, the stock trades with low volume. As a result, this buyback actually represents almost 75 days worth of trades in this stock at its average volume! Needless to stay, the takeout of this many shares could serve to move the stock considerably.

Disclosure: Author has a long position in shares of ALCS

The Strategy of Ben Graham – Warren Buffett’s Mentor

From 1923 to 1957 Warren Buffett’s mentor, Ben Graham, followed a strategy of investing in net-nets. He said: “It always seemed, and still seems ridiculously simple to say that if one can acquire a diversified group of common stocks at a price less than the...net current assets alone…the results should be quite satisfactory. They were so in our experience, for more than 30 years.”
Today net-nets are rare. They are collected under GuruFocus’ Net-Net Screener. GuruFocus also publishes a monthly newsletter which recommends the safest net-nets. All of these are included in GuruFocus Premium Membership.

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