A Pick that Graham Could Agree With--And Did

John Coumarianos: I think the influence of Graham and Briloff has led you to a lot of smaller companies with very simple accounting. And I love the fact that your number-one holding, National Presto, is actually mentioned by Graham in "The Intelligent Investor." Give us the thesis for that, and maybe tell us how it exemplifies your approach.

Charles Dreifus: Well, National Presto was, indeed, mentioned by Graham. I've been running public mutual funds since May of 1980, and I believe one of my first holdings in my first mutual fund was also National Presto. I've owned it probably most of my career, but have sold it at times. Its stock has given me opportunities, as many stocks do, where they rise and then they fall, and if you are familiar with it and you know the business...

What drew Ben Graham to National Presto was Graham's usage of net-net working capital. Net-net working capital simply is current assets minus all liabilities. And you relate that number to the share price, and if it's 100 percent or greater, you're getting the fixed assets for free: the goodwill, the fixed assets, everything like that.

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It's a useful tool as a financial anchor in very severe market declines. During 1973 and '74, and at the low in '82, you were able to buy companies like that. Interestingly enough, at the recent low in March, you didn't get all that many this way; you got some. The higher the proportion of net-net working capital in cash, the better, because we don't know what the inventories and receivables are worth.

Now, these days, the cynic might say we don't know what the cash is worth either, because it could be in auction-rate securities. But that's perhaps being a little bit too cynical.

So the initial attraction of a company like National Presto, and it's a bit of an anomaly. It's an extreme version of, you don't find too many of those, where the net-net working capital and the cash was such a large portion of the share price that you felt you had this financial anchor.

Now, they had an operating business, besides. The operating business was, and is, household appliances, Presto. But over time, they also bought other businesses, one of which, actually, they went back to their roots. During the Second World War, they were making ammunition. One of their recent acquisitions is also in the defense business, making ammunition.

So it's a company that still has incredibly strong financials, and these operating businesses are contributing ever more. And not that I expected it, but frankly, this year, they're doing somewhat better than they had thought they would in the appliance business, because the economy has caused more people to eat at home.

What I'm looking for are, and if we were doing this in my office here at Royce rather than in this conference room, you'd see, on my desk, I have pencils with erasers. I make mistakes, OK? I strive for all of these factors, and I strive for these pristine companies. And even if I attain those, who's to say that my judgment of the earnings levels will maintain themselves?

Coumarianos: But you've got the margin of safety and a great balance sheet. You've got a solid, prosaic business in kitchen appliances and munitions...

Dreifus: Right. They also make some absorbent material. But yes, absolutely. Every step of my process, I'm conscious of trying to reduce risk. I want to take away, ideally... It's a good question, because it made me think of this, which we haven't spoken of, John, is that I want to remove expectations. I want to buy a stock where the expectation is low or nonexistent.

Basically, I'm looking for anomalies, inefficiencies in the marketplace. If I can find those, and if I haven't made an error as to the persistency of earnings, then the stock can languish, certainly, or can be discovered. And if it gets discovered, it can happen many ways, obviously. But if it does get discovered, obviously there's opportunity for the market to more properly adjust to what the value should be.