Business Valuations versus Stock-Market Valuations: The A & P Example

The A. & P. Example.

This was one of Graham's original examples, which dates back many years but which has a certain fascination because it combines so many aspects of corporate and investment experience. Here is the story:

1. It involves the Great Atlantic and Pacific Tea Co.
2. A&P shares were introduced to trading on the "Curb" market, now American Stock Exchange, in 1929 and sold as high as 494.
3. By 1932 they had declined to 104, although the company's earnings were nearly as large in that generally catastrophic year as previously.
4. In 1936 the range was between 111 and 131.
5. Then in the business recession and bear market of 1938 the shares fell to a new low of 36.
6. That price was extraordinary. It meant that the preferred and common were together selling for $126 million, although the company had just reported that it held $85 million in cash alone and a working capital (or net current assets) of $134 million.
7. A&P was the largest retail enterprise in America, if not in the world, with a continuous and impressive record of large earnings for many years.
8. Yet in 1938 this outstanding business was considered on Wall Street to be worth less than its current assets alone - which means less as a going concern than if it were liquidated.
9. Why? First, because there were threats of special taxes on chain stores; second, because net profits had fallen off in the previous year; and third, because the general market was depressed.
10. The first of these reasons was an exaggerated and eventually groundless fear; the other two were typical of temporary influences.
11. Let us assume that the investor had bought A&P common in 1937 at, say, 12 times its five-year average earnings, or about 80.
12. We are far from asserting that the ensuing decline to 36 was of no importance to him.
13. He would have been well advised to scrutinize the picture with some care, to see whether he had made any miscalculations.
14. But if the results of his study were reassuring - as they should have been - he was entitled then to disregard the market decline as a temporary vagary of finance, unless he had the funds and the courage to take advantage of it by buying more on the bargain basis offered.

Sequel and Reflections

1. The following year, 1939, A&P shares advanced to 117 1/2, or three times the low price of 1938 and well above the average of 1937.
2. Such a turnabout in the behaviour of common stocks is by no means uncommon, but in the case of A&P it was more striking than most.
3. In the years after 1949 the grocery chain's shares rose with the general market until in 1961 the split-up stock (10 for 1) reached a high of 70 1/2 which was equivalent to 705 for the 1938 shares.
4. This price of 70 1/2 was remarkable for the fact it was 30 times the earnings of 1961.
5. Such a price/earnings ratio - which compares with 23 times for the DJIA in that year - must have implied expectations of a brilliant growth in earnings.
6. This optimism had no justification in the company's earnings record in the preceding years, and it proved completely wrong.
7. Instead of advancing rapidly, the course of earnings in the ensuing period was generally downward.
8. The year after the 70 1/2 high the price fell by more than half to 34. But this time the shares did not have the bargain quality that they showed at the low quotation in 1938.
9. After varying sorts of fluctuations the price fell to another low of 21 1/2 in 1970 and 18 in 1972 - having reported the first quarterly deficit in its history.

We see in this history how wide can be the vicissitudes of a major American enterprise in little more than a single generation, and also with what miscalculations and excesses of optimism and pessimism the public has valued its shares.

1. In 1938 the busines was really being given away, with no takers; in 1961 the public was clamoring fo the shares at a ridiculously high price.
2. After that came a quick loss of half the market value, and some years later a substantial further decline.
3. In the meantime the company was to turn from an outstanding to a mediocre earnings performer; its profit in the boom-year 1968 was to be less than in 1958; it had paid a series of confusing small stock dividdends not warranted by the current additions to surplus; and so forth.
4. A&P was a larger company in 1961 and 1972 than in 1938, but not as well-run, not as profitable, and not as attractive.

There are two chief morals to this story.

1. The first is that the stock market often goes far wrong, and sometimes an alert and courageous investor can take advantage of its patent errors.
   
2. The other is that most businesses change in character and quality over the years, sometimes for the better, perhaps more often for the worse. The investor need not watch his companies' performance like a hawk; but he should give it a good, hard look from time to time.

Ref: Intelligent Investor by Benjamin Graham

The more recent history of A&P is no different. At year-end 1999, its share price was $27.875; at year -end 2000, $700; a year later, $23.78; at year-end 2002, $8.06. Although some accounting irregulariteis later came to light at A&P, it defies all logic to believe that the value of a relatively stable business like groceries could fall by three-fourths in one year, triple the next year, then drop by two-thirds the year after that.