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The Z-Seven Fund: Promises, Promises, PromisesFebruary 13, 1989 WARREN Buffett, one of the nation's most successful investors, loves to buy stocks selling for two-thirds of their intrinsic value. He likens this to buying dollar bills for 66 cents, a bargain in anyone's book. On the other hand, Barry Ziskin, an otherwise conventional stockpicker who is the proprietor and largest shareholder of the Z-Seven closed-end fund, has added a twist to investing that might make Buffett wince or make old Ben Graham turn over in his grave. Ziskin, a bearded 35-year-old with $150 million under management and a knack for selecting stocks, recommends purchasing his fund's shares at prices significantly above net asset value-in essence, buying dollar bills for $3. Z-Seven went public in 1983 under the stewardship of Ziskin, who had been running money since 1980. According to his firm, Top Fund Management, Ziskin achieved a compounded annual return of 23.6% during 1980-1987, vs. 12.8% for the S&P 500. It should be noted that the better part of Ziskin's performance took place prior to 1984 and before he was running Z-Seven. What sets Ziskin apart from virtually all other money managers is his dogmatic insistence that a dollar's worth of his fund is worth much more than a dollar and his dogged persistence in promoting this idea. A closed-end fund, unlike its open-ended counterpart, is an investment company with a fixed number of shares. Investors can buy and sell the stock, but the company doesn't redeem it. Consequently, it's common for these funds to trade at a discount to their net asset value. Recently, the average discount was about 13%. Interestingly, Z-Seven is the only closed-end, other than single-country funds, that has consistently sold at a large premium to net asset value. This is perhaps due to the fund's small size as well as to Ziskin's assertions about its real value. Z-Seven's corporate moniker comes from the Z in Ziskin's name and the seven criteria he uses to evaluate common stocks:
One thing Ziskin has in abundance is confidence, chutzpah or hubris (just what it is depends on your point of view). In Z-Seven's 1986 annual report, Ziskin predicted that the fund probably would be up more than 38% in 1987, thus marking three years in a row of 38%-plus growth. He added that a 30% annual increase would be a "conservative projection." Ziskin apparently was pleased with the more than 20% premium to net asset value his stock commanded at the time. He wrote: "We are finally on our way to having Z-Seven recognized as an emerging growth company!" To carry the message to the marketplace, Ziskin embarked "on a high-priority campaign to educate investors." In 1987, when NAV was $20, a 30% gain for the year would have been $6 per share. Ziskin equates such projected investment profits with "earnings per share." Thus, he asserted, the fund was selling for less than four times earnings. He further reasoned that "comparing our projected growth goal of 30% compounded annually with Dow {Jones Industrial Average} earnings which are no-growth (or low-growth, at best), it appears that the Z-Seven fund should be valued at a P/E multiple more than five times that of the Dow P/E ratio, instead of the current situation, where it is the absolute reverse." To buttress his point, Ziskin recounted the tale of Battery Group Ltd., an Australian closed-end fund whose stock went up 16-fold in the year after its initial public offering. He modestly remarked that "Z-Seven may yet turn out to be a greater success than" that fund. Certainly, that was his goal. "At this point in my life-at the age of 34 -- I am devoting my energies and skills towards making Z-Seven an unusually profitable investment-for many, many years to come," he wrote. The 1986 annual report includes a table showing projected 30% annual growth in net asset value, as well as a projected stock market price at various P/E ratios. For 1987, when NAV was $22.09 and projected "earnings" were put at $6 a share, the chart showed a possible stock price of 120 at a 20 P/E multiple down the line. At its most extreme, the table holds out the possibility that, by 1997, Z-Seven could have earnings of $82.68 a share, a net asset value of $354.41 and a share price (at a 20 P/E) of a mere $1,653.60. A caption includes an exhortation to read further "to see why these values may be realized." In fairness, it must be pointed out that even Ziskin might view a 20 P/E as a tad on the high side. That's probably why he also writes, "I am conservatively suggesting that our shares have the potential to be valued at ten times earnings." Still, a P/E of 10 would produce a price around 2 ½ times net asset value. How has Z-Seven performed since Ziskin made his comments, which contrast sharply with the modest and mealy-mouthed rhetoric that fills most annual reports? Not fabulously. Although Z-Seven's portfolio was way up earlier in 1987, it got clobbered, along with the rest of the market, in October and ended the year a mere 3.8% ahead. (Net asset value actually declined 0.9% due to the fund's high expense rate-about 4%.) And 1988 wasn't much better, even though small stocks-just the kind Ziskin loves to buy-outperformed the Dow and the S&P. In 1988, the fund was up less than 0.5%. Shareholders who bought stock on Ziskin's rosy 1987 projections can't be happy. The stock price topped out in the high 20s in August of that year. Recently, it was trading around 15, which still represented a 13% premium to net asset value. Long-term shareholders haven't made out like bandits, either. Z-Seven went public at $10 in December 1983. The stock is up 80% after five years (adding back $3.14 of tax credits shareholders received). During this period, net asset value, adjusted for tax credits, has grown at a 13.1% compounded annual rate. The sluggish old Dow has done better during the same time frame. Although Z-Seven's 1987 annual report sports much of the same rhetoric as 1986's, it is toned down a bit-perhaps in deference to the aftershocks of the Crash. On page 26, the fund's goal of 30% compounded growth is referred to as a "bold objective" instead of a "conservative projection." But three pages later, the old phrase returns-the target is again a "conservative projection." In the '87 annual, Ziskin also eliminated one of the most interesting parts of his '86 report-the table that shows a hypothetical 1997 stock price of $1,653. Still, Ziskin says of his $5 million position in Z-Seven stock: "If Z-Seven should reach a 10 times P/E multiple in 10 years, my investment would be worth $310 million at our 30% compounded growth rate goal." In a recent interview with Barron's, Ziskin even compared his fund to Warren Buffett's Berkshire Hathaway Inc., whose stock sells well above book value. There is a difference, of course. Berkshire carries many assets at historical costs far below their current real value. Z-Seven, on the other hand, marks its assets to market each day. So, comparing the two companies isn't very illuminating. Although Ziskin admits it might take 20 years to change the current American perception of how to value closed-end funds-a perception that leans heavily on NAV-he feels that "once the concept is accepted, the demand for this sort of vehicle could be so great that it could almost make the open-end funds obsolete. Everyone would want to get into a situation when it went public that would sell on the basis of its potential return, rather than its assets." In this light, it's worth noting that Ziskin turned bearish toward the end of 1988 and is now about 80% in cash. Despite this, he still argues that "Z-Seven should sell at a big premium to net asset value." In the fourth quarter, investors seem to agree. The fund's share price rose 12.71%, while its net asset value slid 0.85%. |