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Re: The value of Kmart

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By emiller8988
June 9, 2004

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The fascinating thing about this is it demonstrates the power of undervalued assts on the balance sheet

that is your basic 50c on the dollar asset play that made Ben Graham rich. Sooner or later those assets reach their full valuation. Personally, I'd rather find wildly undervalued assets than a growing business. It's very hard to screw up mid-city real estate in San Francisco... but businesses blow up all the time.

The problem with K-Mart is this... I would bet dollars to doughnuts that the insiders/ownership will be sure that none of the undervalued real estate's value will make its way into the hands of marginal shareholders.

In every aspect of life we run into an interesting item. We are often required to measure something to measure something else. What? For instance, in medicine, we are often interested in how much oxygen is available to the cells of the body... but that can't be measured in any reasonable way so we do the next best thing... we measure the oxygen in the blood of arteries and assume it will be available for the cells... it probably will, but not always. If you forget that the arterial oxygen is only a proxy for the thing you really want to know... you will forget to consider those conditions that would cause the connection to break down.

In investing I am interested in the amount of money that will be returned to me. Capital appreciation is only a proxy for future dividends. Present earnings and cash flow are only a proxy for the thing we can't immediately measure... future dividends. Oxygen in an artery of the body is totally useless, it does nothing to sustain life unless it is delivered to the cell... likewise cash flow and earnings are worthless to the marginal investor unless they make their way to dividends at some point. I think many investors have forgotten that... in just the same way that I see many doctors forget that arterial oxygen is only useful when it finally makes it's way to the cells of the body.

For me then... I have amended Peter Lynch's two-minute drill with one other item. With every stock I own, I want to be able to explain how the cash flow will ultimately make it's way into my pocket. The first requirement is that the management/insiders will allow that to occur.

With K-Mart I rate that possibility remote just like Cisco. If I were going to value CSCO's future cash flow... I'd do the usual DCF and at the end I'd ask myself how much of CSCO's cash flow will ultimately be made available to the shareholders, if present management remains intact. I'd say about 25%... so the final value for CSCO should be divided by 4... it's probably a buy in the 3-4 dollar range.

With Berk, that does not pay a dividend, what would be the chance, under present management, that cash flow will ultimately make its way back to the shareholders? I'd say it's about a 99%+ chance that IN THE END... Mr. Buffett will be sure the money ends up where it is supposed to end up.

I think we too often have lost sight of the real value of assets, cash flow, and the like... its value is in direct proportion to the likelihood it will finally rest in the hand of a shareholder.

Whew, I feel better now

e


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