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05-01-2011, 01:10 PM
(05-01-2011, 09:00 AM)d.o.g. Wrote: The management comes for free because it's not worth anything to a buyer. A competitor buying the business will already have their own management in place - they are only after the inventory and the land/warehouse. This particular management is committed, has a dividend policy and is fiscally conservative. These characteristics have value to a long-term minority shareholder. But they are of no value to someone buying the business, for reasons already stated.
You are assuming the buyer is a competitor.
(05-01-2011, 09:00 AM)d.o.g. Wrote: If a business is worth $1 on paper but will only sell for $0.70 in a liquidation or trade sale, then the true realizable value is $0.70. In order to have a good margin of safety, it would be wise to pay $0.50 or less. The "double discount" is required because there is no realistic chance of getting $1. The appropriate reference is $0.70, not $1. The stock market may give you $1 for your shares, but that would be a function of market sentiment rather than fundamental valuation.
The margin of safety comes for buying the assets at a sufficient discount to prevent the loss of capital. A buyer paying $0.70 will have his capital safe. An investor would not pay $0.70 to liquidate it at $0.70.
Off topic:
How much money he is expected to make should be measured differently (although both are expressed in $$). In this case, it would come from the probability of the business continuing to convert inventory into cash. This provides the expected return.
e.g.
ER = (P1) x 0.70 (liquidation value) + (P2) x 1.0 (realizing inventory value without profit)
where P1 = 5%, P2 = 95%
ER = 0.985 or 40% upwards of the purchase price
(05-01-2011, 09:00 AM)d.o.g. Wrote: Steel unfortunately has similar characteristics. In the right size, shape and thickness, it can sell for $1,000 a ton or more. In the wrong dimensions, it may fetch only $200 per ton or less as scrap.
I may not have fully understood this because $0.20 on a dollar is quite unbelievable for wrong dimensions. Wrong dimensions come from 4 main areas
1. Customer gave the wrong specification
2. Supplier delivered the wrong material
3. AEH ordered the wrong material
4. AEH processed the raw material wrongly
All these can be remedied before the steel hits scrap.
This site shows steel / iron scrap prices http://metalprices.com/FreeSite/metals/fe/fe.asp#