Student

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Assignment
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1001032438
1-page Critique

Course Code:

RSM2312

Course Title:

Value Investing

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AM PM
Professor
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Eric Kirzner, Maureen Stapleton

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1001032438

Hammond Manufacturing Company Ltd. Presented by Invest for Value

Net-Net stock with 0% margin of safety Invest for Value team did a good job in finding a stock which
is close to be called as Net-Net i.e. Market Capitalization of the stock is less than Total Current Assets
Total Liabilities. Refer appendix 1 to understand why I say close to Net-Net. My objection with this
investment is that there has to be sufficient margin of safety especially when you are investing in a nanocap. Ben Graham himself suggested that invest in the net-net stocks only when the stock is trading at 2/3rd
or
less of the net margin i.e. Market Cap <= 2/3 * (Total Current Assets Total Liabilities) so that there
is sufficient margin of safety. If things doesnt pan out the way you are expecting, then you have downside
protection. Also, the whole premise behind buying net-net stock is that you will get profited if the firm
liquidates. If the firm does not liquidate then as an investor you will never realize the profits. Given that
Hammond Manufacturing is in business since last 97 years and CEO owns 37.8% of the firm, there is a
minuscule probability that he will allow the firm to be liquidated.
Increasing EBITDA margin YoY is stretch Group has used increase in EBITDA margins of 30 bps
YoY for next 10 years in forecasting FCFF which is a stretch. A firm can push margins consistently only
if it has got strong moat or is a major player in that sector. I dont think either of the two things is true in
case of Hammond. Refer appendix 2.
Absence of a true catalyst Group didnt have a slide for a possible catalyst that can move the stock.
Investing in nano-cap stocks should have a certain catalyst restructuring or involvement of activist
investor or possibility of firm sell-off. Market can stay irrational for longer than you can stay liquid.
Earnings growth assumption cant be a true catalyst in a thinly traded nano-cap stock because a.
forecasting of earnings growth is extremely difficult b. earnings can be extremely volatile (Refer appendix
3). In case of Hammond, earnings has been extremely volatile in last 10 years.
Strong Balance Sheet is Questionable Total current assets of the firm mainly constitute of accounts
receivables and inventory (95%). Though, I remember group mentioned that they had word with the CEO
and he assured about the quality of inventory and receivables, as an investor I wouldnt take managements
analysis word for word. Cash position of the firm ($0.8M) stands at measly 1.9% of the total assets while
short term borrowings ($9.8M) stand at 40% of total liabilities thus questioning the firms strong balance
sheet position.
Valuation of nano-cap firms should be balance sheet based and not income statement based I found
the valuation done by the group to be bit unreasonable. Valuation of a nano-cap based on 10 year forecast
would be highly unpredictable. Consistent increase in revenue and EBITDA margins for 10 years is
definitely a stretch. If I were an investor, I would pay for the firm purely based on the balance sheet
numbers. Assuming quality of inventory and receivables to be good, I would invest if Hammond were
trading below 70% * (Total Current Assets Total Liabilities) i.e. 0.7*(40.6-22.7) = $12.5 million or 77
cents per share. Hence, I would liquidate my position in Hammond at the current stock price of $1.93.

APPENDIX 1: NET-NET STOCK

APPENDIX 2: INCOME STATEMENT PROJECTION

APPENDIX 3: HISTORICAL EARNINGS OF HAMMOND MANUFACTURING

GRADE: __