Successful value investors utilize different strategies when managing money. Warren Buffett epitomizes the investor who looks to buy businesses with ‘economic moats’ at a fair price knowing that the growth of the business will generate a generous return over the next decade.
Benjamin Graham and Walter Schloss focused more on the balance sheet when buying stocks. This strategy tends to limit downside risk when buying a stock. Usually the greatest risk with owning these types of stocks is they end up being dead money for a few years.
Over the past 10 years the strategy detailed below has worked very well for me:
- Look for companies that have no net debt.
- Look to purchase companies selling at less than 60% of tangible book value.
- Look for companies that have a business model or product that will not become obsolete.
- Put up to two percent of your portfolio into the stock.
- Sell the stock when it reaches close to book value.
One company that I think meets the above criteria is dELiA*s (DLIA). The company is a women’s specialty retailer that is currently operating at a loss. There is no moat around this business. Given the poor business dynamics, I do not view this company as a long-term holding.
The stock closed on April 13 at $1.76 per share. The company sells at 59.9% of book value. The company has net cash per share of $1.58 on its balance sheet. I use this as an estimate of the downside risk for the stock. This implies downside risk of 10.2%. Tangible book value per share is $2.94. This is 67.1% above its current stock price.
Using tangible book value as the upside target and cash per share as the downside risk, I think the stock is offering an estimated upside that is about 6 ½ times the estimated downside. If someone offered you the opportunity on a coin flip to make $6.50 if the coin came up heads and pay $1.00 if it came up tails, would you take the bet? I think this is the situation that Delias presents.
One other fact that I like about this stock is that the two very well known value investors, Charlie Royce and Whitney Tilson, each own about 9.5% of the stock. They also increased their holdings in the 4th quarter of 2009 at prices above or close to the current stock price.
I can’t say if this investment will work out. However, if you buy enough of these types of stocks over time, my experience has been you will come out ahead. Successful investing entails putting yourself in a position where the odds are in your favor and limiting your downside risk. I think Delias meets both of these criteria.
Disclosure: Tony Abbate and clients of Granite Value Capital are long DLIA.