Liquidity — part deux

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

First we take Manhattan

3109783051_a8973ac6ce_oIn a previous posting (here) I have discussed how the equities that I invest in have extreme low liquidity, and, therefore, can cause the market capitalization of the underlying company to behave erratically.

In the posting I described one such example when a purchase of 1,000 shares of FORTY, the equity for Formula Systems, representing a value of $18,500 (the equivalent of one model year 2012 Kia Sportage,) caused the capitalization of Formula Systems to decline $6.3 million (the equivalent of 25 model year 2012 Rolls Royce Ghosts).

The comparison of purchasing power for the equity purchase (and sale, of course, as there always has to be a counter-party) and the purchasing power for the economic impact is useful and, I guess, funny, but it is perhaps lacking in scope.

Another, perhaps better, way to understand the magnitude of the low liquidity on the volatility is to view the situation in terms of leverage. So the leverage, let’s call it Low Liquidity Market Capitalization Leverage (or LoLiMaCaLe, for short,) for the $18,500 transaction was 340.5:1. To compare, high-end leverage in ForEx, perhaps the most extreme leverage in the financial industry (go here if you want to be really scared about using leverage in ForEx trading,) is 50:1, a far cry from our LoLiMaCale18.5/6.3.

Here is a way to understand this number: If you could apply your LoLiMaCaLe of 340.5:1 to buying real estate by way of a mortgage, then, if you had a $100,000 down payment, you could move into a $34.1 million dollar home such as the Portabello Estate in California, a private residence on the Pacific Coast that comes with one acre of private beach, a master bedroom of 2,000 square feet (the size of a suburban house,) a movie theater (no, not an entertainment room… a movie theater,) a bowling hall, and — believe it or not — a faux Mary Kay Jeweler shop.

Formula Systems is a holding company with majority interests in three publicly traded companies, an incredibly strong balance sheet, revenues, net income, cash flow, and growth. Moreover, with near zero liquidity it is a value investor’s dream, a gem, undiscovered by the market, and rapidly appreciating in value.

The company, which has over $125 million in cash, zero debt, and extreme positive cash flow, is only held back by its near zero liquidity, with very few investors actually selling their positions in its equity. It has a market capitalization of $285 million and generated income of $24 million in 2012 on top of $57 million in operating income. The per share price of the company’s equity has appreciated 55% since August of 2012 and there seems to be no end in sight for the appreciation.

The combination of a lack of liquidity and a high per share price is what makes FORTY immune from speculators, day traders, and institutional investors, making it possible for small-time investors such as me to, slowly, over time, accumulate a position at a bargain price. It is also, however, what makes the equity unbearable to follow on a day-by-day basis.

Today, for instance, four shares were traded (no, this is not a misprint…. four shares were traded,) at $21.68, up from $21.03 at the open. With a spread of $0.65, this transaction, valued at $86.72 had a positive economic impact of $8.96 million.

In our first, crude purchase model, this could be expressed as a situation where the economic equivalent of a pair of Pacer Heart Throb roller skates (at $79 plus tax) is able to create economic value equivalent to 36 model year 2012 Rolls Royce Ghosts.

In terms of our leverage, this transaction creates a leverage, LoLiMaCale0.1/9.0 of 90,000 (note that we round up… had we not, the leverage would have been 103,422.) If you applied LoLiMaCale0.1/9.0 to your $100,000 real-estate purse, you would have leveraged yourself up to $9 billion, handily enabling you to outbid Larry Ellison in the pursuit of the Lanai island, reportedly going for a measly $500 million.

Or you could just go ahead and put your hands on a good chunk of Manhattan.

Participate, please….

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