When the First World War ended in 1918, the world celebrated peace, but investors on Wall Street suffered. Following the armistice, between 1918 and 1919, the US economy experienced a mild recession as it adjusted to the changing economic conditions. The United States was only actively involved in WWI for 19 months, but during this time the country’s economy mobilized in a way it has never done before. And after a brief recession, growth bounced back in 1920, and the “Roaring 20s” began.
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The market conditions in 1919 and 1920 were perfect for value investors. Benjamin Graham, who has since become known as Godfather of value investing, wasted no time. He profiled some of his best ideas in The Magazine of Wall Street. Today I'm looking at one of these ideas. Titled "The Two 'American Ships'" Graham's article compares two shipping companies, one of which he concludes, is deeply undervalued.
The Two 'American Ships'
The two companies were the "American Shipbuilding Company and the American Ship and Commerce Corporation." It was the former that had attracted Graham's attention.
"Considering the almost complete ignorance of the general public in regard to this company, it might be supposed that it is a small and unimportant proposition, with little in its record to attract the investor's attention. Nothing could be further from the truth. In its last fiscal year, this concern turned out 109 ships of 422,800 gross tons, which alone is considerably larger than the pre-war output of the entire country. The dividend record, the income statements, and the balance sheets of American Shipbuilding in recent years rank among the most remarkable exhibits of the industrial enterprises of the nation. And yet its shares were selling only sporadically and in small lots in Chicago, while the public was growing widely excited over Cramp Ship & Engine in Philadelphia and American Ship & Commerce in New York (the two being closely related as will soon be explained). Which of these issues was most worthy of market enthusiasm should appear from the following comparison."
Before taking a closer look at the American Shipbuilding Company, Graham looks over American Ship and Commerce. This company owned $3.1 million of stock in Cramp Ship & Engine and "76,000 'B' shares of the Kerr Navigation co." He goes on to note that in total, the holding company owns approximately 68% of Cramp Ship & Engine. With this being the case, the rest of Graham's analysis is focused on Cramp.
Comparing these two companies, the first thing the Dean of value investing finds is that American Shipbuilding offers a much more attractive dividend yield. "In comparing Cramp at 140 with Am Shipbuilding at 120, the first item that sounds out in favor...is its far more liberal dividend policy." The author says before going on to note that in 1918 AM Shipbuilding paid out a total of $27 per share compared to Cramp's 6. In 1919, AM Shipbuilding distributed $16 compared to Cramp's 6.
"It starts 1920 with a quarterly dividend of $4, payable Feb. 1, which rate was maintained throughout 1919, in the form of 7% regular and 9% extra. In 1918 it disbursed $27 per share, of which 15% was in 3 ½ % Liberty Bonds. Cramp, on the other hand, has only paid $6 per share during these past two years."
Graham then goes on to consider the companies' earnings potential:
"But the superiority of Am. Shipbuilding becomes much more remarkable when the figures in the annual reports are analyzed, as is done in Table II. Strange to say, the adjusted statements show exactly the same earnings for the common in 1918 and 1919, before deducting maintenance, depreciation, and taxes. In both years these profits reached the astounding total of $18,480,000, or over $243 per share. The much smaller final surplus in 1919 is due to much more liberal charges for upkeep and amortization, these aggregating practically $100 per share, against $57.50 in 1918. The tax deduction alone in 1919 exceeded $96, or 80% of the present market price. While the exact amount of taxes reserved by Wm. Cramp is not stated in the report, the balance sheet figures show it to be much smaller than in the case of Am. Shipbuilding and the depreciation charges are certainly insignificant in comparison. In the last two fiscal years, these have averaged only $360,000, or $6 per share, against $3.300,000, or $4372 per share, for the Great Lakes company."
And then the focus moves to the balance sheet, where once again AM Shipbuilding has the advantage.
Graham notes that AM Shipbuilding at the time had a total market capitalization of $15.5 million, reporting aggregate assets of $152 million. "Of this, $23,638,000 or $231 per share of common is held in cash and Liberty Bonds alone, against which there are current liabilities of only $2,272,000 and a tax reserve of $9,618,000." The author goes on to say that other assets on the balance sheet included $100.4 million of "work in progress" and liabilities of $107,377,000 which are primarily funds advanced by the government.
Graham goes on to write that "American Shipbuilding owns certainly much the larger and more valuable facilities." A table of assets shows AM's number of construction plants at eight to Cramp's three and number of building berths at 13 to Cramp's eight. AM also has 15 drydocks. Cramp has none. After producing 109 vessels in the 1918 to 19 period, "American Shipbuilding still had uncompleted orders for 63 vessels, more than the entire output of William Cramp during the war period." After further analysis of the output and earnings potential of both companies, Graham reaches the following conclusion:
"To sum up, American Ship & Commerce is about 40% William Cramp and 60% Kerr Navigation. Whether the profits of the latter interest will fully justify its cost it is hard to say; but it is certain that the price paid for the William Cramp shares was far too high as compared with the market quotations at that time for American Shipbuilding Co. The latter company would seem to have reaped such enormous profits in the recent past as to be worth substantially more than its current price, without regard to future developments."
This originally appeared at ValueWalkPremium.com
