Why Central Securities Corporation Looks Attractive

Central Securities Corporation (CET) is a closed-end fund that organized in 1929 and runs a concentrated portfolio mainly invested in US stocks. It is attractively priced and currently sells at a discount to NAV of 18.81%. Part of the reason for the large discount is that about 30% of the assets are invested in a single illiquid restricted investment with a very low tax basis, The Plymouth Rock Company. Plymouth Rock sells auto insurance and has performed very well for CET over the years.

When a fund values a portfolio, there are three kinds of “fair value” based on the observability of the market price.

• Level 1 — Quoted prices in active markets on major exchanges.
• Level 2 — Other significant observable data obtained from independent sources; for example quoted prices for similar investments or the use of models or other valuation methodologies. For CET, the Level 2 investments consist of short-term investments, carried at amortized cost.
• Level 3 — Investments in which there is little, if any, market activity. CET owns two Level 3 securities- a large position in The Plymouth Rock Company, Inc. and a small $300,000 position in Aerogroup International, Inc.

The fund purchased 70,000 shares of Plymouth Rock equity back in 1982 and 1984 for a total cost of only $2.2 million and they currently value that stock at $2,000 a share or $140 million.

But the CET valuation seems too low for Plymouth Rock. Every year, Plymouth Rock commissions an outside and independent appraisal of their stock. The last appraisal was in early 2009 and the fair market valuation was $3265 a share. After applying a 20% discount for lack of marketability, the discounted price value is $2610 which is substantially higher than the $2,000 value actually used by CET management to compute the NAV of its portfolio. The overall market has appreciated considerably since early 2009, so the current fair market price for Plymouth Rock would be even higher.

Here are some other bullet points on CET as a long term investment:

1. Low expense ratio: The annual expense ratio has traditionally been very low- around 0.60%. But in the last semi-annual report it was rose to 0.83% due to the drop in assets that occurred in 2008 and early 2009. Since June 2009, assets have grown and the next reported expense ratio should decrease again.

2. Low turnover ratio: The CET management does very little trading and the last reported turnover ratio was only 2.53%. So the “hidden” trading costs caused by the bid-asked spread and adverse market impact are very low compared to most other mutual funds and closed end funds.

3. Good long term investing performance: As of 9/30/2009, the 10 year annualized NAV return for CET was 5.42%. Morningstar places CET in the top 1% of its category for that time period.

4. The top ten stock holdings for CET as of September 30, 2009 were:

Stock Name . . . . . . . . . . . . . . . . . . % of Net Assets
Plymouth Rock . . . . . . . . . . . . . . . . . . . 29.4%
Agilent Technologies (A) . . . . . . . . . . . . . . . . 5.4%
Brady Corp (BRC). . . . . . . . . . . . . . . . . . . . . . . . . 4.6%
Bank Of NY Mellon (BK) . . . . . . . . . . . . . . . . . . 4.1%
Coherent Inc (COHR). . . . . . . . . . . . . . . . . . . . . . . 4.1%
Murphy Oil Corp (MUR). . . . . . . . . . . . . . . . . . . . 3.6%
Convergys Corp (CVG) . . . . . . . . . . . . . . . . . . . . . 3.5%
Dover Corp (DOV). . . . . . . . . . . . . . . . . . . . . . . . . 3.3%
Intel Corp (INTC) . . . . . . . . . . . . . . . . . . . . . . . . . . 2.9%
Devon Energy Corp (DVN). . . . . . . . . . . . . . . . . . 2.8%

Comments

[Phil S:]

Where did you see the $3265 valuation on Plymouth Rock? Is there more detail on how that figure was arrived at?

Nov 03 11:24 AM

[Phil S:]

Re: expenses, turnover, and track record:

0.83% is decent as an expense ratio by equity CEF standards, but it's high in comparison to certain non-CEF alternatives (Vanguard, etc.).

2.53% *is* a low turnover, but here's a thought: If you divide the amount of money on which something was changed this year by the ER, it looks like the price of having this money managed is pretty high. i.e. For every $2.53 in turnover, you are spending about $0.83 in expenses/management.

Unless that $2.53 constitutes amazing decision making, really what you are doing by investing in this fund is buying a basically passive portfolio of stocks, with a somewhat high cost structure relative to the actual investment management that is going on. The track record may be solid, but how much of that is attributable to the decision to invest in Plymouth Rock? (A decision that I think was made over 25 years ago.)

That said, CET appears solid on these factors (expenses, turnover, and track record) in comparison to many equity CEFs, and the discount makes the overall package more interesting. Thanks for the article.

Nov 03 11:30 AM

[Phil S:]

OK, I see where the valuations of Plymouth Rock are listed on their site (easy to find under "Common Stock Appraisals"). I think that may be relatively new - I think I've poked around on that site before and not seen that.

You say the appraisal was done in early 2009 - anything more specific on the time frame?

Nov 03 11:59 AM

[49er:]

If you compare CET to the S&P doing 1 year, 5 year, 10 year and maximum charts (and it looks as if CET has less of a distribution than the S&P) CET comes out as the loser. In the short term it has done better.

Nov 04 08:46 AM

[Shale Gas:]

Everyone should go to the Plymouth Rock site and read the management letters by the guy who runs Plymouth Rock. He provides some very insightful commentary on the market.

Nov 04 08:59 AM

[Shale Gas:]

here's the link:

www.prac.com/about-us/...

Read the chairman's letter going back several years.

Nov 04 09:02 AM

[Shale Gas:]

Go to page 6 of this one:

www.prac.com/about-us/...

He wrote this just before the tech bubble popped in 1999.

Nov 04 09:05 AM

[Eric Fox:]

Question - you say that the fair value is $3265 a share. What is the tangible book value per share of PRAC? Liquid publicly traded insurers will usually trade at a multiple of tangible book value.

Nov 04 09:18 AM

[Eric Fox:]

George...it's interesting that CET was probably one of the Closed end funds that were part of the 1929 mania that you wrote about here:

quantinvestor.wordpres.../

I wonder how many others besides CET are still around.

Nov 04 09:21 AM

[Eric Fox:]

Investors interested in CET should read this article. It is very old but mentions a lot about CET and Wilmot Kidd, its manager.

www2.bc.edu/~holderne/ConOwnershi...

Nov 04 09:30 AM

[Eric Fox:]

Here's the link, it didn't go through on the previous message:

www2.bc.edu/~holderne/ConOwnershi...

Nov 04 09:31 AM

[Eric Fox:]

Let's try it again:

www2.bc.edu/~holderne/

click on research and then on article entitled:

Concentrated Ownership and Discounts on Closed-End Funds

Nov 04 09:33 AM

[TBill:]

Agree, CET doesn't deserve to be trading at that steep discount. Well managed, conservative fund.

Nov 04 11:14 AM

[richmcn:]

CEF's at a discount are a valuation puzzle, a bit like a bond stripped of it's coupons. Upon reading the financial statements, you see interest and dividend income come in, and the expenses go out at about the same level, and three years in ten, the residual leftover is capital gains . . . is that really seeking alpha?

Nov 04 11:04 PM

[Gwailo:]

> Eric Fox has asked a very good question: "What is the tangible book value per share of PRAC? Liquid publicly traded insurers will usually trade at a multiple of tangible book value."

After knocking out goodwill and deferred acquisition costs, PRAC shareholder's equity at end of '08 was $262mm = @ $1,440/sh. Revenue/sh was about $2,500 and after-tax income was @ $196/ sh, for a @ 13% ROE.

For comparison, the Yahoo stats on Progressive Corporation (PGR) show trailing P/E of 11.8x, P/Sales of 0.76 and P/Book of 1.97, with an 18.7% ROE. So $2,000 - $3,200/sh for PRAC looks to be within the range of reason.

As for CET, note that Wilmont Kidd, who has run the fund for the last 30 years or so, is now age 68, that Kidd family trusts hold about 14% of the stock, and that Mrs. Kidd's family foundation owns an additional 34%. CET makes a very decent long-term core holding with a midcap emphasis, but don't expect any activist action here.

As for that 2.53% turnover ratio, sometimes it's better to pay fund managers *not* to buy or sell. Didn't a Warren Buffet shareholder letter a few years back quote Pascal, to the effect that most of our troubles come from not being able to sit still?

'Gwailo ("Et ferme ta bouche.")

Nov 05 04:33 AM

[George Spri...:]

Last week, CET declared a year-end distribution of $0.55 per share. The dividend is payable December 23, 2009 and shareholders may elect to receive the distribution in stock or cash. The "default" choice if you make no election is to receive more stock.

As CET makes these distributions every year, Plymouth Rock gradually becomes a larger percentage of the NAV. As time passes, CET will trade more and more like Plymouth Rock and less like a diversified fund. The CET management team should consider applying the management fee only to the non-Plymouth Rock assets.

Nov 16 05:47 PM

[George Spri...:]

Eric-
I've listed below some of the CEF's issued in 1929 during the new issue boom.

I know Tri-Continental (ticker:TY) is still around, but I don't think any of the others have survived aside from CET.

Chicago Corp
Mayflower Associates
Tri-Continental Corp.
Shenandoah Corp
Interstate Equities
Central Securities
Blue Ridge Corp
American Equities


On Nov 04 09:21 AM Eric Fox wrote:

> George...it's interesting that CET was probably one of the Closed
> end funds that were part of the 1929 mania that you wrote about here:
>
>
> quantinvestor.wordpres.../
>
>
> I wonder how many others besides CET are still around.

Nov 16 06:20 PM