What's a Stock Worth Today?

By Jason Zweig Sunday, July 28, 2002
    • Worldcom investors are in a world of hurt. They should have listened to a dead analyst, not a live one. In fact, the WorldCom bankruptcy has a lot to teach us about analyzing companies, and now, as the markets are searching for a bottom, is a great time to put those lessons to use.

    Not long ago, Jack Benjamin Grubman was on top of the world. The Salomon Smith Barney telecommunications analyst was pulling down $20 million a year, and every big investor knew Grubman was the "ax," the one man who could make or break any stock in his industry with a thumbs-up or thumbs-down. Today Grubman is in the gutter. WorldCom was one of his favorite stocks. Investors are livid, and regulators are looking into whether he violated professional ethics by touting telecom stocks for the investment-banking fees they would earn for his firm.


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    I have a more basic beef with Grubman: I question not his ethics but his analysis. (Since when has anyone seriously expected virtue on Wall Street?) In congressional testimony, Grubman declared that the job of a stock analyst is "to make judgments about the future prospects of companies." In other words, by projecting past growth rates and forecasting future trends, analysts like Grubman seek to figure out what a company will be worth down the road.

    Benjamin Graham (who died in 1976) would not have applauded Grubman. Graham — market-stomping money manager, finance professor at Columbia, mentor to Warren Buffett — was the greatest investment mind of the 20th century.

    He insisted that the analyst's job is, first and foremost, to figure out what a stock is worth right now. He believed in comparing a company's share price to its existing assets and past earnings. Only after determining a stock's value today would Graham entertain guesstimates of what it might earn tomorrow. Anchoring his analysis in reality gave Graham what he called "the margin of safety." As he wrote in his classic The Intelligent Investor, "Operations for profit should be based not on optimism but on arithmetic."

    How does this relate to Grubman? His mistake wasn't that he guessed wrong about WorldCom's future; the company was lying about its numbers. His mistake was that he ignored the present.

    Even as WorldCom's future kept looking rosier to Grubman (see chart), its balance sheet, its "now," was imploding. At the end of 1999, the company claimed $10.3 billion in current assets and $30.3 billion in current liabilities and long-term debt. By year-end 2001, current assets had shrunk to $9.2 billion, while current and long-term debt had swollen to $39.2 billion. Graham liked companies whose current assets were at least twice their current liabilities. This measure, called the current ratio, tells you the working-capital cushion a company has at its disposal. Graham also believed that long-term debt should not exceed working capital. WorldCom's working capital sank to a negative $8 billion in 2000 even as its long-term debt was burgeoning — to more than $30 billion in 2001. WorldCom was making a mockery of Graham's "margin of safety."

    But Grubman kept hollering "buy," all the way down to $6 a share. (Grubman did not respond to my requests for comment; a Salomon Smith Barney spokeswoman says Grubman "now admits that his thesis was wrong.")

    The ultimate irony: if Graham were alive today, he would probably be bargain hunting among the very stocks that Grubman used to like. Some of Graham's top fans are running mutual funds such as Legg Mason Value, Longleaf Partners, Oakmark, Royce, Third Avenue Value and Tweedy Browne. Among the telecom stocks favored by at least one of these managers: AT&T;, Level3, Nextel, Telephone & Data Systems and Tellabs. Consider too the Dow Jones Telecommunications Sector index fund (symbol IYZ; see www.ishares.com ). Graham groupies are rummaging through the tech wreckage as well, buying stocks like Comverse Technology and Instinet.

    Jack Grubman probably hates today's grinding bear market, but Ben Graham would have loved it. Telecom and technology stocks may not be this cheap again for years to come. Grubman now rates many of his stocks "speculative" or "high risk"; yet before they lost at least 90% of their value, he called them "moderate" risk. Graham, on the other hand, would say they were high risk before — but low risk now. Jack says "sell," but Ben would surely say "buy!"

    E-mail Jason, a columnist at Money magazine, at fundamentalist@moneymail.com