- bonds and preferred stocks selling well under par, as well as
- bargain common stocks.
- This relies largely on estimating future earnings and then multiplying these by a factor appropriate tot he particular issue.
- If the resultant value is sufficiently above the market price - and if the investor has confidence in the technique employed - he can label the stock as a bargain.
- This value also is often determined chiefly by expected future earnings - in which case the result may be identical with the first method (the method of appraisal).
- In the second test more attention is likely to be paid to the realizable value of the assets with particular emphasis on the net current assets or working capital (current asset - current liabilities).
[A typical example would be General Motors when it sold at less than 30 in 1941. It had been earning in excess of $4 and paying $3.50, or more, in dividends.]
It is true that current earnings and the immediate prospects may both be poor, but a level-headed appraisal of average future conditions would indicate values far above ruling prices.
The wisdom of having courage in depressed markets is vindicated not only by the voice of experience but also by application of plausible techniques of value analysis.
[Example of the first type (a): In 1946, Lee Rubber & Tire Company, aided by the bull market and by steadily rising earnings, the stock sold at 72. In the second half of 1947 the reported profits fell off moderately from the previous year's figures. This minor development apparently generated enough pessimism to drive the shares down to 35 in early 1948. That price was much less than the working capital alone (about $50 per share) and no greater than the amount actually earned in the previous five years.]
[Example of the second type (b): During the 1946-47 period the price of Northern Pacific Railway declined from 36 to 13.5. The true earnings of Northern Pacific in 1947 were close to $10 per share. The price of the stock was held down, in great part, by its $1 dividend. It was neglected, also, because much of its earning power was concealed by conventional accounting methods.]
The Intelligent Investor