Investing Tools for Investors Looking to Excel
10/21/02  

Rationalization can consist of spin-offs, sales of unproductive units, write-offs of dead assets, reengineering of the business to lower on-going business costs or goose revenue growth by better marketing or exploiting new distribution channels, or the purchase of compatible businesses to add scale and efficiency. Economies of scale refer to the idea of running increasing volumes through the same overhead structure, with a resulting benefit to operating margins and profitability. 

Value can exist on the balance sheet. For instance, a home builder who acquired land for future development at recession level prices. This land can be worth far more as economic activity increases, carrying land values with it. Home builders sell dirt, they just happen to have houses on them. That dirt may be valued well under market. Oil and mineral rights, timber rights, etc. acquired at the depths of economic slumps can have great value, as well.

The Cable TV stocks upgraded their cable plant and realized that coaxial cable and fiber could allow the CATV company to be more than just one way entertainment delivery. While upgrades are necessary, these CATV companies now aspire to deliver local telephony and Internet Access, in addition to their standard entertainment fare. 

Entertainment distribution revenues have also mushroomed as the same cable plant can deliver far more programming for far more revenue. As this realization of future cash flow potential and hidden value seeped into the marketplace, the stock prices doubled. However, the technical feasibility and performance of these new services is an open question and provides a ceiling on the stocks.

A new challenge to cable's entrance to high speed internet access is Digital Subscriber Lines, which allow old copper to provide transmission even faster than cable's theoretical capacity. Not only that, but the subscriber pays the costs of the equipment at his or her premises to provide those high speeds. The point of this is that unearthing value can involve some technical expertise the average investor or even money manager simply does not possess.

AT&T paid premium prices to get into cable when it purchased TCI and UMG, on the presumption that the price did not take into account future cash flows from local telephony and internet access. However, there are significant capital upgrades to realize the dream and technical issues surrounding system performance degradation as more subscribers are added. In the technical realm, value is difficult to pin down, even for those in the field. While questions plaque AT&T, the local bells are employing DSL and the relative stock performance of the Regional Bell Operating Companies (RBOC's) versus AT&T tells this sad tale. 

Value investing takes work to delve into the various elements of a business's balance sheet to understand hidden values, determine the effect on cash flow if changes were made. Further, understanding what skill sets new management brings to conduct a reengineering of the business. For instance, when John Sculley supplanted Steve Jobs and lit a marketing fire under Apple, it was a great coup. Eventually, his poor technical vision caused the company to swoon and turn to Jobs once more to restore a winning technical vision. Still think management does not matter?

IBM, ATT and Scott Paper are good examples of value investing victories, while  Sunbeam is an example of a failed effort to resuscitate a company plagued by too much competition, too few customers (Walmart, Eckerd, etc.) famous for beating up their suppliers, no pricing power, and an inability to cut costs to compensate for no revenue growth.

Another aspect of value is buying stocks that look cheap on a fundamental basis even if they do not have hidden or unrecognized balance sheet values, unproductive assets that can be sold, or bad management that could be replaced. More about this approach in Fundamental Analysis.

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