The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [182]
Pair I: Real Estate Investment Trust (Stores, Offices, Factories, etc.) and Realty Equities Corp. of New York (Real Estate Investment; General Construction)
In this first comparison we depart from the alphabetical order used for the other pairs. It has a special significance for us, since it seems to encapsulate, on the one hand, all that has been reasonable, stable, and generally good in the traditional methods of handling other people’s money, in contrast—in the other company—with the reckless expansion, the financial legerdemain, and the roller-coaster changes so often found in present-day corporate operations. The two enterprises have similar names, and for many years they appeared side by side on the American Stock Exchange list. Their stock-ticker symbols—REI and REC—could easily have been confused. But one of them is a staid New England trust, administered by three trustees, with operations dating back nearly a century, and with dividends paid continuously since 1889. It has kept throughout to the same type of prudent investments, limiting its expansion to a moderate rate and its debt to an easily manageable figure.*
The other is a typical New York-based sudden-growth venture, which in eight years blew up its assets from $6.2 million to $154 million, and its debts in the same proportion; which moved out from ordinary real-estate operations to a miscellany of ventures, including two racetracks, 74 movie theaters, three literary agencies, a public-relations firm, hotels, supermarkets, and a 26% interest in a large cosmetics firm (which went bankrupt in 1970).† This conglomeration of business ventures was matched by a corresponding variety of corporate devices, including the following:
A preferred stock entitled to $7 annual dividends, but with a par value of only $1, and carried as a liability at $1 per share.
A stated common-stock value of $2,500,000 ($1 per share), more than offset by a deduction of $5,500,000 as the cost of 209,000 shares of reacquired stock.
Three series of stock-option warrants, giving rights to buy a total of 1,578,000 shares.
At least six different kinds of debt obligations, in the form of mortgages, debentures, publicly held notes, notes payable to banks, “notes, loans, and contracts payable,” and loans payable to the Small Business Administration, adding up to over $100 million in March 1969. In addition it had the usual taxes and accounts payable.
Let us present first a few figures of the two enterprises as they appeared in 1960 (Table 18-1A). Here we find the Trust shares selling in the market for nine times the aggregate value of Equities stock. The Trust enterprise had a smaller relative debt and a better ratio of net to gross, but the price of the common was higher in relation to per-share earnings.
TABLE 18-1A. Pair 1. Real Estate Investment Trust vs. Realty Equities Corp. in 1960
In Table 18-1B we present the situation about eight years later. The Trust had “kept the noiseless tenor of its way,” increasing both its revenues and its per-share earnings by about three-quarters.* But Realty Equities had been metamorphosed into something monstrous and vulnerable.
How did Wall Street react to these diverse developments? By paying as little attention as possible to the Trust and a lot to Realty Equities. In 1968 the latter shot up from 10 to 37 3/4 and the listed warrants from 6 to 36½, on combined sales of 2,420,000 shares. While this was happening the Trust shares advanced sedately from 20 to 30¼ on modest volume. The March 1969 balance sheet of Equities was to show an asset value of only $3.41 per share, less than a tenth of its high price that year. The book value of the Trust shares was $20.85.
TABLE 18-1B. Pair 1.
The next year it became clear that all was not well in the Equities picture, and the price fell to 9½. When the report for March 1970 appeared the shareholders must have felt shell-shocked as they read that the enterprise