The only way to make consistent money in the market is to think like a businessman. When you buy a stock, act like you are purchasing the entire business — not a ticker on a screen. Because when you think like a businessman over a stock trader, your returns will instantly get better.

When you buy a stock you are buying ownership in a portion of the free cash flows that a business will generate in the future. You are not buying a line on a screen. You are not buying momentum. And you are not buying a hint your buddy told you about. All you are buying is the future free cash flows a business will generate.

All that matters at the end of the day is the cash a business will throw off and how many years it will take for investors to get a return on the capital they invested.

Technical indicators, momentum in a stock, obscure hints on messages boards and the likes of all of the gurus you see on the internet claiming they have the secret recipe to high stock market returns might work in the short-run, but in the long-run they are dead, floating in the water.

The secret to consistently winning the stock market has been out for almost 100 years. This secret was published in 1934, written by Benjamin Graham, in the famous Security Analysis, a game changing book for all investors who think and act like businessmen.

Security Analysis was a ground breaking book that laid the foundation for the intellectual school of thought called Value Investing. In the book Graham coined the term Margin of Safety, which would propel a significant amount of value investors into the realm of stardom who used these techniques including the famed Warren Buffett.

The principals laid out in Security Analysis and later The Intelligent Investor have transformed a number of “students of the market” into intelligent business minded and price oriented investors, including myself.

As Warren Buffett stated

My financial life changed with that purchase of Intelligent Investor. Ben’s ideas were explained logically in elegant, easy-to-understand prose. Of all the investments I ever made, buying Ben’s book was the best.

I have read The Intelligent Investor numerous times which has single handily changed the way I conduct myself in the public markets.

I don’t buy stocks. I buy deeply discounted businesses for 50-75% off.

I focus 70% of my time on balance sheet analysis and 30% of my time trying to forecast future cash flows derived from the income statement.

I look for companies with underappreciated assets on the balance sheet that could potentially be liquidated for more than what the company is worth. If I am wrong in my analysis on forecasting cash flows, I rely on balance sheet assets to protect my downside.

My formula for success in the market is as follows

• Buy a business near or under liquidation value (I calculate this myself based on a number of different scenarios depending on the security)

• Have at least 25% annualized upside over a two year time frame from potential cash flows that could be generated.

• Aggressively average down when you have 0% downside and significant upside.

The stock market is a finicky beast and tends to price businesses at extreme lows and extreme highs many times during market cycles.

It’s easy to find large and mega-cap stocks priced at extreme highs during many portions of the market cycle. But to find a mega-cap priced at liquidation value you need an event like the depths of the March COVID-19 lows to occur.

On the other hand, it is not as hard to find small and micro-cap stocks priced at extreme lows where in fact you can buy the assets below liquidation value.

As an example, take this company that I am currently in the process of underwriting.

This company has 44 large manufacturing facilities throughout the world.

The company doesn’t disclose the square footage of these facilities so I will have to do additional analysis to figure out the size of these assets. But as a background, this company manufactures parts for automobile companies. Manufacturers of auto-parts typically have extremely large facilities.

I am not going to disclose the name of this company as I am still underwriting and want to keep it close to my vest (paid subscribers to Alpha Letter will get a first look when I publish my findings), but I will give some valuation stats.

• Market Cap: $120 million

• $1 billion in debt

• $250 million in cash

• $909 million enterprise value

Comparing the market cap to the enterprise value, without any additional information, clearly points to a distressed equity situation.

This company has struggled to generate free cash flow in the midst of COVID, the supply chain and higher inflation. Investors have given up on the stock and sold it off.

I am not finished underwriting the company but I suspect it is trading near or under its current liquidation value.

One reason why I think it is trading under its current liquidation value is from note 8 in their annual report. Disclosed in note 8 is the total cost of all property, plant and equipment.

As seen in the picture, total property, plant and equipment before depreciation is over $1.6 billion in value.

Property, plant and equipment is held at historical costs which typically means that the land and buildings in this table are discounted to the true value or replacement cost of these assets.

One way I can tell these assets are discounted to the true value is from a sale the company performed in 2019.

In 2019, this company sold a single product line that consisted of a manufacturing facility for $265 million.

This product line had $326 million in sales in 2019, a mere fraction of the $2.3 billion in sales this company generated in 2021.

Based on the sale of this single product line and the owned assets held at historical cost on the balance sheet I have reason to believe the stock is trading at liquidation value.

And to put icing on the cake, management recently said they are looking to sell one of their manufacturing facilities over the next couple quarters to free up some liquidity.

My thought is if the company can turn around their business, the stock is a multi-bagger. If the management team can’t and there is a permanent impairment, I think they can liquidate the assets for more than what the current valuation is at.

Given the high level of debt outstanding, underwriting this company is an important process to make sure I don’t suffer an permanent loss in capital.

Always think like a businessman and never lose money. Those are my two most important rules when investing.

Other Examples of Buying Under Liquidation Value

I was buying coal mines under liquidation value in mid-2021.

Coal prices were starting to surge and the equity in coal stocks was flat to down.

From my research I conducted, coal stocks appeared to be trading under their liquidation value and had no love from the market, despite the recent surge in coal prices.

I wrote up and invested in a number of coal stocks, but my best one was Alpha Metallurgical (AMR).

I wrote Alpha up on August 4th when the stock was at a mere $28 per share. On Friday, Alpha closed at $158 per share, netting anyone who invested and held for under a year, a 357% return.

During this time I was slamming my fist on the table almost everyday saying what a great opportunity it was to own coal stocks. I wasn’t right at first, and received a lot of hate mail.

Eventually my analysis paid off and anyone who held coal stocks through the rut made a fortune.

Another company I recently started purchasing is a small urban retailer. See here if you are a paid subscribers so you know what stock I am talking about.

This stock has a market cap of $272 million and an enterprise value of $222 million. The management team recently disclosed they are selling two of their facilities for $69 million after taxes and fees. This puts the implied enterprise value at $153 million.

This company has 609 locations and it costs around $350k-375k to open a new location. If you take the 609 current locations and divide it by the $153 million implied enterprise value you are buying this stock for $252k per location, which is under the liquidation value, or replacement cost.

The stock is beaten down as they are coming up against a tough quarter compared to 2021. Despite the tough quarter, the company is forecasting to generate strong free cash flow and the management team wants to grow aggressively.

When I am buying into a situation like this I think to myself, “do I want to own this entire business at the current value?” Based on my analysis, the answer to this question is yes.

Buy businesses, not stocks

If you act like a businessman and not a stock picker you will instantly start to improve in the public markets.

Managing money is serious business.

When you are allocating tens of millions of dollars you need to treat the market with upmost respect.

Conduct yourself like a businessman and buy portions of businesses not stocks.

Become an Alpha Letter Pro subscriber today and learn the art of value investing by a former hedge fund analyst.

With Alpha Letter Pro you get access to all of my past research reports and any future research report.

All of my analysis is conducted on stocks trading near or under their liquidation value. I take a position in everything I write about and eat my own cake.

Feel free to reply to this email if you want a sample of my past research.

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