I mentioned Monday I was putting together a list of companies that traded near or below my estimated liquidation value and, as expected, I got several e-mails asking the same question. Everyone wanted to know how to derive a valid estimate of this value.
In the interests of both not giving away the farm and also teaching a man to fish, I will tell you that the formula I used is a variation of the ones outlined in "Security Analysis" by Ben Graham and "Margin of Safety" by Seth Klarman. You need to read both of these books to practice asset-based value investing anyway, so you may as well get started. Martin Whitman's "Aggressive Conservative Investor" will also assist you in calculating an appropriate liquidating value.
I want to stress the words "approximate" and "estimate." I do not perform the fine-detail investigation I see in so many analysts' reports from Wall Street. I really do not need to know what the company is paying for tissue paper in the chairman's private bathroom or the cost of the wrapper of a product. I just need to have an idea of what the inventories and properties will sell for in an orderly sale process. I do not need to be overly precise in this calculation. If I am mostly right, most of the time I will end up making money from a portfolio of stocks selling below liquidation value. If it remains a going concern then the stock price will improve and if they do liquidate, or more likely are acquired, then the transaction should occur above my purchase price.
I spent some time yesterday casting my net for stocks that are close to my estimate of liquidating value. If the full schedule of news and event this week should weigh on stocks, these would be attractive long-term investments if they trade at a discount to estimated liquidating value. The first stock I uncovered is an old favorite. I own and have discusses Sterling Construction (STRL) for some time after selling puts to create a long position. Fellow contributor Sham Gad also recently mentioned the stock favorably.
Sterling is in a business that I think will eventually become a market-leading boom sector. The highway construction business has been dormant the past few years as municipal spending has been curtailed and Congress has dragged its heels passing a new highway spending bill. Business is not great and management admits that it will not get a lot better until we get a long-term federal highway bill. They are staying buys and are fortunate that two of its key markets, Texas and Utah, have weathered the recession better than most. They loans recently landed a contract in California and the order backlog is growing. Management estimates that $592 million of the $741 million contract backlog will be executed in 2012.
In addition to roads, Sterling also does water infrastructure construction as well as airport and light rail construction. The water infrastructure markets in particular could be a strong source of growth for this company in the years ahead. Their primary markets are in the water-starved Southwest portion of the United States where, as the population grows in the decades ahead, the need for water-related infrastructure will climb rapidly. Sterling operates in markets that will be among the growth leaders in construction spending over the decade once the economy gains a solid footing.
The stock is cheap here as results have flat lined amid difficult conditions. Tangible book value is $9.75 and using a Graham intrinsic value calculation I find an IV for the company of $12 a share. With the stock at $9.79 it is tempting. My calculation of liquidating value right now is roughly $8.75 a share and if we get downside volatility in the stock market that takes the stock below that number I will buy more shares of Sterling. With more than $60 million of cash and very little long-term debt the stock is not only cheap it appears to be safe as well. I am not the only one who likes the price of the stock as insiders, including the new chief financial officer, have recently been buying shares of the company.
Thanks ot the short term nature of the markets we can by this stock for a slight premium to the liquidation value of the corporation. If we are really lucky and the markets fall on European election news we may even get the shares at a discount to my estimate of that value.