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Schloss 1965

The document discusses repurchasing company stock and whether book value should be considered. It presents opposing views from Walter Schloss and Charles Ellis on if book value is an important factor. While Schloss believes book value should be weighed, Ellis argues earnings are more relevant and book value often understates asset values.

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1K views2 pages

Schloss 1965

The document discusses repurchasing company stock and whether book value should be considered. It presents opposing views from Walter Schloss and Charles Ellis on if book value is an important factor. While Schloss believes book value should be weighed, Ellis argues earnings are more relevant and book value often understates asset values.

Uploaded by

Logic Gate Capital
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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From The Thoughtful Businessman December 1965

From: Walter J. Schloss


Re: Purchase Stock to Revitalize Equity

! I have read Mr. Ellis" article carefully and am in agreement with his objectives. I
would like to comment on one phase of this problem, however.
! I can understand the reluctance of management to repurchase its stock at, say,
$30 a share when the company"s stock has a $10 book value. For example, assume a
company has 2,000,000 shares of stock which have a book value of $10 and earn $3 a
share. To repurchase 500,000 shares at $30 a share would cost the company
$15,000,000, and assuming it could borrow some of the money to finance the purchase,
the 1,500,000 shares remaining would have a book value of $3.33. Not a very
prepossessing figure, despite the fact that earnings would now approach $4 a share. It
also assumes good earnings for the future, which are never guaranteed.
! Assume, however, a company"s stock has a $100 book value, selling at $45 and
earning $3 a share, with 2,000,000 shares outstanding. If the company repurchased
1,000,000 shares at $50 a share, the book value for the remaining shares would
increase to $150 a share, and the earnings would increase to close to $6 a share.
! My point is that a large book value would help the company repurchase its stock
since it would give it a bigger base from which to operate. It would also increase book
value for the remaining shareholders instead of decreasing it.
! I cite the above example because it is typical of what Crane Company has done.
I think Ellis should have discussed this phase in his study. In fact, those companies with
large book values in relation to market prices offer the stockholder the greatest rewards,
and this is the one area that I don"t think Ellis covered.

From: Charles Ellis


Re: Repurchase Stock to Revitalize Equity

! Given the examples provided in Mr. Schloss"s letter, I would agree that a
company whose shares are selling below book value might find share repurchasing
highly appropriate, particularly when substantial non-operating liquid assets are
available. Many casualty insurance companies and some closed end investment
companies clearly fall within Schloss"s observation. In general, however, I believe that
an emphasis on book value is not appropriate for decision making in non-financial
companies.
! First book value is often misleading because historic acquisition costs ignore
rising values of long lived assets and sizable expenditures to maintain the efficiency and
the value of the facilities. Moreover, accelerated depreciation is often deducted.
Consequently book value is typically substantially understated. On the other hand,
trademarks, patents, management capability, and consumer franchises -- all vital to
corporate earnings power and often worth far more than capital goods -- are excluded
from book value.
! Second, the mere presence of substantial assets may be irrelevant to
repurchasing if they are (a) illiquid or (b) necessary for continued operations. On the
other hand, many companies whose shares sell far above book value have substantial
liquid assets and unused debt capacity available for repurchasing.
! Third, while asset values are surely of primary importance in privately held firms,
in publicly held companies the investors exercise no direct control over assets and must
therefore, concentrate on the profits which are generated from them.
! Finally, a corporation buying its own shares is not buying an asset. The company
is making a single present payment in exchange for the termination of the stockholder"s
“right”to participate in future earnings of the enterprise. Consequently, the relevant
analysis of repurchasing is not present assets, but future earnings.

From: Walter J. Schloss


Re: Repurchase Stock to Revitalize Equity

! I am not convinced by Mr. Ellis" argument that book value is unimportant in the
repurchase policy of corporations except in the case of the repurchase of insurance and
closed-end investment companies at a discount. While I realize that he places his
emphasis on earnings, it is also true that earnings are much more likely to fluctuate than
are book values, and therefore estimating longer term earnings than, say, the next year
or so can be subject to serious error. For example:
! If the management of Alpha Portland Cement had repurchased 800,000 shares
of its stock at $30 a share in 1960 when it was earning $2.66 a share, it could
subsequently be criticized for its policy when a few years later earnings took a tumble
due to severe competition and the stock sold down to $11 a share in 1965. To say that
the stock market erred in its estimate of the future is really not answering the question,
because the cement industry has a brilliant future ahead of it. In 1956 Alpha sold as
high as $47 with earnings of $3.45, and in 1958 sold over $42 a share earning $3.06 the
following year.
! My point is that if the assets are large enough, the stockholders benefit by
repurchases at discounts from book value and that the purchase of stock above book
value in times of prosperity can be later criticized if earnings decline through no fault of
management but simply because the vicissitudes in the industry.
! It is true that value should be determined by what a company can earn in the
future, but the fact that this is an objective should not allow management's to ignore
book value. The fact that book values tend to be understated in terms of today"s prices
is another reason to give some weight to large book values in industrial companies.

--MrMarketBlog.com

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