Security Analysis : Sixth Edition, Foreword by Warren Buffett: Additional Aspects of Security Analysis. Discrepencies Between Price and Value by David L. Dodd
Authors: David L. Dodd
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41 bid in 1939.
A similar situation arose in the case of United Shipyards Corporation stock after ratification of the sale of its properties to Bethlehem Steel Company in 1938. Dissenting holders brought suit to set the sale aside on the ground that the price was grossly inadequate. The effect of this litigation was to hold down the price of the Class
B
common to 1¼ in January 1939, as against a realizable value of between 2½ to 3 if the sale was upheld. Obviously, if the suit had any merit, the stock should have been worth more rather than less than 2½; alternatively, if it had no merit, as seemedclear, then the shares were clearly worth twice their selling price. (A similar disparity existed in connection with the price of the Class
A
stock.)
Undervalued Investment Issues. Undervalued bonds and preferred stocks of investment caliber may be discovered in any period by means of assiduous search. In many cases the low price of a bond or preferred stock is due to a poor market, which in turn results from the small size of the issue, but this very small size may make for greater inherent security. The Electric Refrigeration Building Corporation 6s, due 1936, described in Chap. 26, are a good example of this paradox.
At times some specific development greatly strengthens the position of a senior issue, but the price is slow to reflect this improvement, and thus a bargain situation is created. These developments relate usually to the capitalization structure or to corporate relationships. Several examples will illustrate our point.
Examples
: In 1923 Youngstown Sheet and Tube Company purchased the properties of Steel and Tube Company of America and assumed liability for the latter’s General Mortgage 7s, due 1951. Youngstown sold a 6% debenture issue at 99 to supply funds for this purchase. The following price relationship obtained at the time:
The market failed to realize the altered status of the Steel and Tube bonds, and thus they sold illogically at a higher yield than the unsecured issue of the same obligor company. This presented a clear-cut opportunity to the analyst to recommend a purchase or an exchange.
In 1922 the City of Detroit purchased the urban lines of Detroit United Railway Company and agreed to pay therefor sums sufficient to retire the Detroit United Railway First 4½s, due 1932. Unusually strong protective provisions were inserted in the purchase contract which practically, if not technically, made the City of Detroit liable for the bonds. But, after the deal was consummated, the bonds sold at 82, yielding more than 7%. The bond market failed to recognize their true status as virtual obligations of the City of Detroit.
In 1924 Congoleum Company had outstanding $1,800,000 of 7% preferred stock junior to $2,890,000 of bonds and followed by 960,000 shares of common stock having an average market value of some $48,000,000. In October of that year the company issued 681,000 additional shares of common for the business of the Nairn Linoleum Company, a large unit in the same field, with $15,000,000 of tangible assets. The enormous equity thus created for the small senior issues made them safe beyond question, but the price of the preferred stock remained under par.
In 1927 Electric Refrigeration Corporation (now Kelvinator Corporation) sold 373,000 shares of common stock for $6,600,000, making a total of 1,000,000 shares of common stock, with average market value of about $21,000,000, coming behind only $2,880,000 of 6% notes, due in 1936. The notes sold at 74, however, to yield 11%. The low price was due to a large operating deficit incurred in 1927, but the market failed to take into account the fact that the receipt of a much greater amount of new cash from the sale of additional stock had established a very strong backing for the small note issue.
These four senior issues have all been paid off at par or higher. (The Congoleum-Nairn Preferred was called for payment at 107 in 1934.) Examples of this
A similar situation arose in the case of United Shipyards Corporation stock after ratification of the sale of its properties to Bethlehem Steel Company in 1938. Dissenting holders brought suit to set the sale aside on the ground that the price was grossly inadequate. The effect of this litigation was to hold down the price of the Class
B
common to 1¼ in January 1939, as against a realizable value of between 2½ to 3 if the sale was upheld. Obviously, if the suit had any merit, the stock should have been worth more rather than less than 2½; alternatively, if it had no merit, as seemedclear, then the shares were clearly worth twice their selling price. (A similar disparity existed in connection with the price of the Class
A
stock.)
Undervalued Investment Issues. Undervalued bonds and preferred stocks of investment caliber may be discovered in any period by means of assiduous search. In many cases the low price of a bond or preferred stock is due to a poor market, which in turn results from the small size of the issue, but this very small size may make for greater inherent security. The Electric Refrigeration Building Corporation 6s, due 1936, described in Chap. 26, are a good example of this paradox.
At times some specific development greatly strengthens the position of a senior issue, but the price is slow to reflect this improvement, and thus a bargain situation is created. These developments relate usually to the capitalization structure or to corporate relationships. Several examples will illustrate our point.
Examples
: In 1923 Youngstown Sheet and Tube Company purchased the properties of Steel and Tube Company of America and assumed liability for the latter’s General Mortgage 7s, due 1951. Youngstown sold a 6% debenture issue at 99 to supply funds for this purchase. The following price relationship obtained at the time:
The market failed to realize the altered status of the Steel and Tube bonds, and thus they sold illogically at a higher yield than the unsecured issue of the same obligor company. This presented a clear-cut opportunity to the analyst to recommend a purchase or an exchange.
In 1922 the City of Detroit purchased the urban lines of Detroit United Railway Company and agreed to pay therefor sums sufficient to retire the Detroit United Railway First 4½s, due 1932. Unusually strong protective provisions were inserted in the purchase contract which practically, if not technically, made the City of Detroit liable for the bonds. But, after the deal was consummated, the bonds sold at 82, yielding more than 7%. The bond market failed to recognize their true status as virtual obligations of the City of Detroit.
In 1924 Congoleum Company had outstanding $1,800,000 of 7% preferred stock junior to $2,890,000 of bonds and followed by 960,000 shares of common stock having an average market value of some $48,000,000. In October of that year the company issued 681,000 additional shares of common for the business of the Nairn Linoleum Company, a large unit in the same field, with $15,000,000 of tangible assets. The enormous equity thus created for the small senior issues made them safe beyond question, but the price of the preferred stock remained under par.
In 1927 Electric Refrigeration Corporation (now Kelvinator Corporation) sold 373,000 shares of common stock for $6,600,000, making a total of 1,000,000 shares of common stock, with average market value of about $21,000,000, coming behind only $2,880,000 of 6% notes, due in 1936. The notes sold at 74, however, to yield 11%. The low price was due to a large operating deficit incurred in 1927, but the market failed to take into account the fact that the receipt of a much greater amount of new cash from the sale of additional stock had established a very strong backing for the small note issue.
These four senior issues have all been paid off at par or higher. (The Congoleum-Nairn Preferred was called for payment at 107 in 1934.) Examples of this
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