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Chapter 43: Significance of Current Asset Value

The current asset value is generally a rough index of the liquidating value – the money that the owners could get out of it if they wanted to give it up. Such liquidations are of everyday occurrence in the field of private business. By contrast, however, they are very rare indeed in the field of publicly owned corporations.

·         The first rule of calculating liquidating value is that the liabilities are real but the value of assets must be questioned. This means that all true liabilities shown on the books must be deducted at their face amount. The value ascribed to assets, however, will vary according to their character. In the typical case the noncurrent assets are likely to realize enough to make up most of the shrinkage suffered in the liquidation of the current assets. Hence, current assets value affords a rough measure of the liquidating value.

·         When a common stock sells persistently below its liquidating value, then either the price is too low or the company should be liquidated.

§  Stocks selling below liquidation value are in many cases too cheap and so offer an attractive medium for purchase.

§  In many cases it is also a signal that mistaken policies are being followed and that therefore the management should take corrective action.

·         Common stocks in this category practically always have an unsatisfactory trend of earnings. The objection to buying these issues lies in the probability, or at least the possibility, that the earnings will decline or losses continue and that the resources will be dissipated and the intrinsic value ultimately become less than the price paid. It may not be denied that this does actually happen in individual cases. On the other hand, there is a much wider range of potential developments which may result in establishing a higher market price.

§  The creation of an earning power commensurate with the company’s assets as a result of general improvement in industry or favorable change in company operating policies with or without change in management.

§  A sale or merger, because some other concern is able to utilize the resources to better advantage.

§  Complete or partial liquidation.

·         Discrimination required in selecting such issues: There is scarcely any doubt that common stocks selling well below liquidating value represent on the whole a class of undervalued securities. They have declined in price more severely than the actual conditions justify. This must mean that on the whole these stocks afford profitable opportunities for purchase. Nevertheless, analyst should exercise as much discrimination as possible in the choice of issues falling within this category. He will lean towards those for which he sees a fairly imminent prospect of some one of the favorable developments listed above. Or else he will be partial to such as reveal other attractive statistical features besides their liquid asset position e.g. satisfactory current earnings or a high average earning power in the past. The analyst will avoid issues that have been losing their current assets at a rapid rate and show no definite signs of ceasing to do so.

·         Investment in such bargain issues need to be carried out with some regard to general market conditions at the time. This type of operation fares best when price levels are neither extremely high nor extremely low. The purchase of cheap stocks when market as a whole seems much higher than it should will not work out well, because the ensuring decline is likely to bear almost as severely on these neglected stocks issues as on the general list. On the other hand, when all the stocks are very cheap, there would seem to be fully as much reason to buy undervalued leading issues as to pick out less popular stocks.

·         A common stock representing the entire business cannot be less safe than a bond having a claim to only a part thereof. This seems to be saying that the market value of common stock, without any debt in the capital structure, could not be less than the amount of debt that can be safely issued (investment grade).

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