If you are a value investor, here’s another metric to add to your toolbox: Net worth. It’s the subject with which Christopher Browne opened chapter five of “The Little Book of Value Investing”, published in 2006.
Net worth is a straightforward idea; add up everything a company owns and subtract what it owes. What’s left is net worth and if you divide that by the number of shares outstanding you arrive a company’s book value (net worth per share).
Browne said that when he searched for bargain stocks, he began with stocks selling for less than their book value. It was also one of the key criteria for Benjamin Graham, Browne’s mentor. The author added it had helped him “uncover some tremendous bargains over the years.”.
One of the reasons the firm Tweedy, Browne (of which Christopher Browne was a principal) had a close connection with Graham was because it brokered stocks selling below book value, “Bill Tweedy made markets in shares of obscure stocks that frequently sold at deep discounts to their net worth. This led to his relationship with Ben Graham, as these were exactly the type of stocks Graham was looking to purchase.”
As a historical side note, Tweedy, Browne partner Tom Knapp later convinced the firm to become an investment manager rather than broker by explaining that the firm should hold these stocks for capital gains rather than trade them right away.
And that strategy paid off. The author reported the firm bought National Western Life Insurance (NWLI, Financial) in 1994 at about half its asset value. By 2006 the shares had appreciated 600%, what Peter Lynch would call a “six-bagger”.
In addition to this anecdotal evidence, he also referenced the findings of others, “From the esteemed Barton Biggs to Nobel Prize winners, study after study confirms that value stocks outperformed growth in every country studied (mostly the United States, the United Kingdom, and European countries) by a substantial margin.”
The number of opportunities also expanded when international equities became readily available in the U.S. For example, Browne found serious profits in the stock of Volkswagen (VW, Financial); again, he picked it up at half of its book value and while he held it, it doubled in value.
In addition to stocks selling at less than their book value, he also lauded stocks selling below their net cash balances. These rarities were a favorite of Graham’s, and because they were hard to find, it helped to search global as well as domestic stocks.
In chapter six, Browne went on to point out that about half of all the world’s publicly traded companies were based in the U.S., while the other half were global or international (as of 2005/06). Therefore, American investors could double their chances of finding cheap stocks if they looked beyond their own borders.
What’s more, at the time, 12 of the world’s 20 biggest companies, ranked by sales, were based in Europe and Asia:
“Think of the companies that produce some of the products and services you run across every day: Nestlé, ING financial services, Honda, Toyota, Glaxo Smith Kline, Bayer, Sony, Samsung, Hyundai, Mitsubishi, Carnival Cruise Lines, Fuji Film, and Heineken Beer. All are large, well-known companies whose products we use or see nearly every day of our lives. To ignore global opportunities means not investing in many of the world’s largest and finest corporations.”
Other experts have recommended foreign stocks to achieve geographic diversification, but Browne was skeptical (and he was writing before the 2008 financial crisis). He felt that globalization was pushing most markets into a similar orbit, and that a situation in one could affect many others. As a result, he was recommending non-domestic stocks only because they presented additional opportunities.
There were still situations, though, in which different markets did not move in tandem, again bringing in opportunities. For example, he noted that Japanese and European stocks were much less inflated by the Internet bubble of the late 1990s than American stocks. Indeed, the collapse of Asian markets in 1998 meant there were numerous bargains in Asia at a time when American stocks were widely overvalued.
Another example occurred at the end of the 1980s, when East and West Germany were reuniting. West Germany was forced to print high volumes of its marks to offset the near-worthless East German marks. That led to inflation and higher interest rates, thus depressing European markets for a time.
Browne’s first exposure to foreign markets came in the early 1980s, a time when most Japanese stocks were rising rapidly, and it appeared there were few bargains. Through a friend, he was alerted to Japanese insurance companies; like other equities there, they appeared overvalued, but Browne was told the market valuations reflected an idiosyncrasy in the regulations. Just months after Browne bought into eight insurance companies, regulators changed reporting requirements and the insurance stocks jumped from one-third of book value to full book value.
He concluded chapter six with these words: “By using a global approach, you can double the potential opportunities to stock the shelves of your value investing store and also put yourself in a position to benefit when other markets and companies are cheaper than your home-based counterparts.”
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
