One investor that I closely follow is Martin Whitman of Third Avenue Funds. He is a classic Graham-ist with some very interesting opinions on investing. Here is a short quote on accounting:
ER: You’ve been quoted as saying that it is still possible to find Ben Graham’s “net-nets”, is this still true?
MW: Yes. However we need to realize that GAAP is not really reality. It is not economic truth. It doesn’t tell you what your income or asset value is any more than the Internal Revenue code does. GAAP defines current assets as assets that can be converted to cash in less than one year and arbitrarily classifies certain assets as current and others as fixed. If Kmart has $3 billion in inventory, it can only liquidate its inventory if it goes out of business.
Inventory in retail is a fixed asset of the worst type. Not only is it permanent in the aggregate, but it’s hard to value and is subject to shrinkage and style change. To call it a current asset is not realistic. Retail inventory is only a current asset in the case of liquidation not in the case of a going concern. On the other hand if a company owns income producing real estate and has triple A tenants with long-term leases in class A office buildings, then it can easily pick up the telephone and sell the properties or refinance them. The company can quickly get the cash out. It may be called PPE but it is a much more current asset than Kmart’s inventory. So we define current assets as assets that are readily liquefiable. Using this definition we certainly do find companies which are trading below their economic ‘net-net’ value.
Thank you for the work you have put into this post, this helps clear up a few questions I had.
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