The New Corporate Sobriety
Ben Graham's stock picking methodology was to look for "Cigar Butt"
companies that he could buy very cheaply. These was businesses in distress
that like a discarded cigar butt had one or two more puffs left in them.
If a company was selling for less than the cash left over after all liabilities
had been paid, then it was a pretty safe bet that something good would happen
even if the company went under.
One of the reasons that such companies existed is that after the great
depression, companies were religious about holding onto cash. The reasoning
was that you couldn't go broke if you didn't owe any money. So managers
were tight fisted and cash was conserved.
As the fifties turned into the sixties and Graham retired, corporate thinking
changed. Growth became the most important thing and leverage rose and rose.
One piece of modern financial thinking that took hold was that the capital
structure didn't really matter. That whether the company was financed through
debt or equity was not really important. Companies that kept too much cash
were considered stodgy and behind the times.
When leverage works, it works great. You borrow at 6% and grow at 12% and
it seems like free money. But when it stops working, it stops working all
of a sudden, especially if the debt is short term or callable. Because exactlly
the wrong time for it to go away is exactly when everyone is twitchy and wants
to not roll-over the loan.
I think the last six months are a generational turning point in the business
world. With famous names like Bear-Sterns and Lehman Brothers getting bought
out or going bankrupt and the credit markets seizing up, I think that business
people who experience this are going to come out the other side with a different
attitude. And I think that attitude will include holding onto cash much more than
it used to. I also think it will involve dialing leverage back a few notches.
Yes, you can lever up 40 to one, but remember who's genative organs are in the vise.
I think the days of plentiful Graham style "more net cash than the value of the
company" are long gone. The business world has learned a lot since those days
and most of the cigar butts now have poly drug resistant tuberculosis.
But it wouldn't surprise me if in times to come,
there were a few more bargains and a few less
pets.coms floating around out there.
Chris - I have this great idea for a business that uses expensive delivery methods on very low margin products