Debt Capacity Bargain

In Security Analysis - 1934 edition, BG (Benjamin Graham) talks about companies which are debt-free and their stock price is trading at very low multiples of CFO/Profit. His logic is : A Common Stock Representing the Entire Business Cannot Be Less Safe Than a Bond Having a Claim to Only a Part of Thereof.

BG gives example of a company called The American Laundry Machine to illustrate his point. For simplicity I will take a ficitious company A. Company A is debt free and earns Profit before tax of 100 crore annually(say 5 year average). Now suppose A goes to bank and asks for loan. The appraiser from bank will see the fundamentals of company and will conclude that A can support interest of 40-45 crores annually and if current interest rate is 10%, A can support loan of 400-450 crore easily for forseeable future. If industry of A is stable, without undergoing rapid changes and A has dominant position in the industry, it will add-on to comfort of bank in extending loan.

Now come to think of it. If a bank opens its credit line of 400-450 crores for A and in return expects the annual interest payment and can have claim on SOME PART OF "A" for return of loan, VALUE of whole of A must be lot more than 400-450 crore. So if A trades at market cap less than 400 crore, any investor buying shares of A is virtually getting the upside of equity claim and downside of a fixed claim of a bond. Investor can just buy the shares of A and wait for the market value to reach in a zone where he is not getting the benefit of fixed claim so that he can sell.

Will publish the modified post some time next week....

First Post

Hello,

Finally after long procrastination I finally got down to start my blog. I have started this blog to discuss themes of Value Investing and stock ideas based on them. I would be sending the email invitations to people who I think would be interested in sharing their thoughts. If you find this blog helpful, please let that know to your friends. However if you do not like anything, feel free to write to me. Inititally I would be adding the investment valuation methods from Security Analysis - 1934 edition but as time and our knowledge progresses we can add more content. I would be very grateful if you mention any points/concerns through which my views on any stock are proved WRONG.

Apart from aforementioned points I would be posting book reviews/articles reviews.

Thanks in advance for taking your time out for visiting my blog
Ashish