The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [229]
Sequel 1965–1970
In 1965 new interests came into the company. The unprofitable building-maintenance business was sold out, and the company embarked in an entirely different venture: making electronic devices. The name was changed to Haydon Switch and Instrument Co. The earnings results have not been impressive. In the five years 1965–1969 the enterprise showed average earnings of only 8 cents per share of “old stock,” with 34 cents earned in the best year, 1967. However, in true modern style, the company split the stock 2 for 1 in 1968. The market price also ran true to Wall Street form. It advanced from 7/8 in 1964 to the equivalent of 16½ in 1968 (after the split). The price now exceeded the record set in the enthusiastic days of 1961. This time the overvaluation was much worse than before. The stock was now selling at 52 times the earnings of its only good year, and some 200 times its average earnings. Also, the company was again to report a deficit in the very year that the new high price was established. The next year, 1969, the bid price fell to $1.
QUESTIONS: Did the idiots who paid $8+ for this stock in 1968 know anything at all about the company’s previous history, its five-year earnings record, its asset value (very small)? Did they have any idea of how much—or rather how little—they were getting for their money? Did they care? Has anyone on Wall Street any responsibility at all for the regular recurrence of completely brainless, shockingly widespread, and inevitable catastrophic speculation in this kind of vehicle?
6. Tax Accounting for NVF’s Acquisition of Sharon Steel Shares
1. NVF acquired 88% of Sharon stock in 1969, paying for each share $70 in NVF 5% bonds, due 1994, and warrants to buy 1½ shares of NVF at $22 per share. The initial market value of the bonds appears to have been only 43% of par, while the warrants were quoted at $10 per NVF share involved. This meant that the Sharon holders got only $30 worth of bonds but $15 worth of warrants for each share turned in, a total of $45 per share. (This was about the average price of Sharon in 1968, and also its closing price for the year.) The book value of Sharon was $60 per share. The difference between this book value and the market value of Sharon stock amounted to about $21 million on the 1,415,000 shares of Sharon acquired.
2. The accounting treatment was designed to accomplish three things: (a) To treat the issuance of the bonds as equivalent to a “sale” thereof at 43, giving the company an annual deduction from income for amortization of the huge bond discount of $54 million. (Actually it would be charging itself about 15% annual interest on the “proceeds” of the $99 million debenture issue.) (b) To offset this bond-discount charge by an approximately equal “profit,” consisting of a credit to income of one-tenth of the difference between the cost price of 45 for the Sharon stock and its book value of 60. (This would correspond, in reverse fashion, to the required practice of charging income each year with a part of the price paid for acquisitions in excess of the book value of the assets acquired.) (c) The beauty of this arrangement would be that the company could save initially about $900,000 a year, or $1 per share, in income taxes from these two annual entries, because the amortization of bond discount could be deducted from taxable income but the amortization of “excess of equity over cost” did not have to be included in taxable income.
3. This accounting treatment is reflected in both the consolidated income account and the consolidated balance sheet of NVF for 1969, and pro forma for 1968. Since a good part of the cost