In an earlier post, I said that the only stocks in the U.S. showing up on Ben Graham type screens right now are retailers.
Here are 5 of those retailers:
(All numbers are taken from GuruFocus)
What do I mean when I say a Ben Graham screen?
There are three ways to go with this. A “Ben Graham screen” could mean: A) a screen that uses a single, specific formula Graham developed (like a net-net screen), B) a screen that uses a checklist that Ben Graham laid out for investors in one of his books (like the criteria he lists for “Defensive Investors” in “The Intelligent Investor”), or C) a screen that tries to duplicate the approach Ben Graham used in his own Graham-Newman investment fund.
Here, I chose “D” which I would define as adhering to the “spirit” of Graham rather than the letter of any Grahamite law.
What do I consider the spirit of Ben Graham?
1. Don’t pay too high a price relative to a stock’s earnings (eliminate high P/E stocks)
2. Don’t pay too high a price relative to a stock’s assets (eliminate high P/B stocks)
3. Don’t buy stocks with a weak financial position (eliminate low F-Score stocks)
4. Don’t buy unproven businesses (eliminate stocks that either lost money or didn’t exist sometime within the last 15 years)
5. And needless to say: don’t buy into frauds (eliminate U.S. listed stocks that operate in China)
If you apply those 5 filters to all U.S. listed stocks, you’re left with just 5 stocks:
These are all retailers. And, obviously investors are concerned that Amazon and others will put offline retailers out of business. Do I think Ben Graham – knowing internet retailers were coming for these stocks – would buy a basket of these 5 retailers today?
The Warren Buffett of the 2010s wouldn’t. But, the Ben Graham of the 1950s would.
The reason I’m so sure Graham would buy these 5 stocks if he were alive today is that they all share the same exact value proposition. The bear case is speculative (future oriented). The bull case is historical (past oriented).
Graham’s approach was always to bet on the basis of the past record you do know and against the future projections you don’t know.
The quote he opened Security Analysis with is from the Roman poet Horace:
“Many shall be restored that now are fallen; and many shall fall that are now in honor.”
These 5 stocks are all fallen angels. In almost all past years, they were valued more highly than they are today. They are the common stock equivalent of junk bonds.
Hibbett Sports (HIBB) – P/E 7, P/B 0.9, F-Score 6
Hibbett Sports runs small format sporting goods stores in mostly rural America. The best way I can sum this up is that if you drive through an American town where Wal-Mart is the main retail destination for just about anything, there will be a Hibbett Sports. However, if you drive through an American town where there’s a big format supermarket, or a Best Buy, or a Nebraska Furniture Mart or an Ikea anywhere in sight – you’re not going to find a Hibbett there. Instead, you’ll find something like a Dick’s Sporting Goods (DKS). The average Dick’s location is about 50,000 square feet. The average Hibbett location is about 5,000 square feet. Quan and I considered researching Hibbett Sports for the newsletter. Just based on his reading of various company filings, Quan had concerns about the Hibbett business model’s survival as sporting good retail shifted more online. After travelling more in towns where Hibbett is located, I pretty much eliminated this stock as something I’d ever consider buying. I could be completely wrong to do that. But, Hibbett serves a very weird purpose where it’s basically in towns that can’t support a sporting goods store with a wide selection. Online retail isn’t great at a lot of things (it’s often not cheaper than offline). But, the one thing online can always do better than offline is bring a wider selection of products to places that used to be offered only a narrow product line-up.
Bed Bath & Beyond (BBBY) – P/E 7, P/B 2.1, F-Score 6
Bed Bath & Beyond is a category killer in soft stuff for the home. Of the stocks that come up on this screen, Bed Bath & Beyond is clearly the best positioned competitively – at least offline. The company’s position is similar to something like Barnes & Noble (BKS), GameStop (GME), or Best Buy (BBY). If anything in this company’s category survives in an offline form – it’ll have to be Bed Bath & Beyond. The most recent earnings release showed online sales growing 20% a year. Meanwhile, offline same store sales declined at a “mid-single digits” rate. I was surprised to see this stock show up on a Graham screen I created. That’s because I was surprised to see it has a P/E of 7. Even more amazing is the current market cap divided by the 15-year average net income is only 6. It’s very rare to find a stock trading for a single digit P/E relative to its average net income over the last 15 years. For perspective, Bed Bath & Beyond is 3 times larger today than it was 15 years ago. And yet the stock is only trading at 13 times what it earned back in 2002. This is definitely a Ben Graham stock.
Kohl’s (KSS) – P/E 12, P/B 1.5, F-Score 8
This company has a solid past record. However, as a department store, it faces the most competition from both the online front and the offline front of any of the stocks on this list.
Genesco (GCO) – P/E 8, P/B 0.9, F-Score 7
This company operates the Journeys, Lids, and Schuh stores. They mostly sell shoes, caps, and apparel to mallgoers in their teens and twenties. They also own the Johnston & Murphy shoe brand. Last year, almost three-quarters of earnings came from the Journeys part of the business. Journeys sells shoes to teenagers. It’s not a business I feel I could ever learn enough about to judge. So, I could never buy the stock. But, I imagine Ben Graham could as part of a basket.
Ingles Market (IMKTA) – P/E 10, P/B 1.0, F-Score 7
Ingles Market runs about 200 supermarkets (and owns over 150 of them) in North Carolina, South Carolina, Georgia, and Tennessee. Ingles is undoubtedly the most “Grahamian” stock on this list. The P/E is reasonable at 10. And the price-to-tangible book is very reasonable at 1 times book. It’s also clear from reading the company’s 10-K that book value understates market value, replacement cost, etc. So, this company is selling for less than its net assets.
Those assets include:
· 155 existing supermarkets
· 18 undeveloped sites suitable for a new supermarket
· “numerous outparcels and other acreage adjacent to” its supermarkets and shopping centers
· 3 million square feet of leasable shopping center space not used by its own supermarkets
· A 1.65 million square foot distribution center / headquarters
· The 119 acres on which the distribution center / HQ is located
· A 139,000 square foot warehouse
· The 21 acres on which that warehouse is located
· A 140,000 square foot milk production/distribution center along with truck fueling/cleaning site
· The 20 acres on which those buildings are located
All that plus equipment and trucks is held at a depreciated cost of just under $1.25 billion on the company’s books.
The company also has 38 supermarkets under very long-term leases (like 30+ years if the company chooses to renew). I believe these are the result of a sale and leaseback transaction done sometime in the late 1980s or early 1990s. Long-term leases (although a balance sheet liability) are often the most valuable economic asset a good supermarket company has.
On the downside: Ingles also has a lot of debt. It’s about $850 million of debt versus just $200 million to $250 million of EBITDA (so, net debt is almost 4 times EBITDA). That’s a lot of debt for a supermarket operator to carry. But, $850 million of debt doesn’t sound excessive relative to the list of real estate assets I just gave you. Most of the debt ($700 million) is due in 2023 (so just over 5 years from now).
The most important fact here is that it appears that at least two-thirds of all the assets I mentioned were already owned by Ingles in 1992. That was 25 years ago. To adjust for inflation, anything put on the books in 1992 – and obviously, almost all of these assets listed here were put on the books before 1992 (that year is just the furthest I could go back using EDGAR) – would need to be adjusted up in value by about 70% to take 25+ years of inflation into account.
If you make this inflation adjustment to Ingles Market’s property, plant, and equipment line you’d be adding $28 a share in book value adjusted for inflation. That would make book value adjusted for inflation $52 a share versus a stock price of $24.50 a share right now. It seems very likely that Ingles has at least $2 in shareholder assets for every $1 of market price on the stock. In fact, the stock is probably trading for well under 50% of the fair market value of its net assets.
The company is family controlled through super-voting “B” shares. The 10-K says Ingles considers real estate operations to be an important part of their business. And, of course, if you adjust past return on equity to reflect what the property Ingles controls is probably really worth – earnings have always been very small relative to assets.
Ingles has never been a compounder. Over the last 30 years, the stock badly underperformed the overall market – and that was true even before it dropped 49% in price this year.
Ingles looks like your typical dead money stock. It’s definitely your typical Ben Graham bargain.
Ingles is the one stock on this list that stands out as being an asset play more than anything else.