‘Renaissance of Value’ postponed
Posted on October 27, 2008 by Richard Beddard
Filed Under Companies, Investing, Markets |
I thought I’d discovered the holy grail of value investing. A company so cheap, you can buy its shares for less than two-thirds of its net working capital, or the balance sheet value of its cash, stock, and receivables assuming it has already repaid everything it owes.
Such bargains are rare, except in deep bear markets. I discovered 600 (that’s the company’s name), which manufactures and distributes machine tools (lathes), in a list published by behavioural investing analyst James Montier at the end of September. As world stockmarkets have crashed, so the number of ‘net-nets’ has slowly increased. Mr Montier’s list identified 175, most of them in Japan.
There are probably more now, but in September, 19 UK net-nets populated the list including seven construction companies, and seven companies with stockmarket valuations less than your average footballer earns in a year. Figuring house builders’ assets are melting away as I type, and the others are just too small:
- Northamber (NAR - computer hardware),
- Dawson International (DWSN - cashmere clothing),
- Abbeycrest (ACR - jewellery), and…
600 might be worth investigating.
I’m frustrated though. At its balance sheet date in March, 600’s current assets were £47m and its total liabilities £26m, so net working capital was about £21m. Compare that to the value placed on its shares by the stock market (£11m) and you can see they are selling for just over half 600’s net working capital.
Would Benjamin have bought? Net-net’s were the grandfather of value investing’s favoured strategy. Near the end of his career in 1974, Benjamin Graham gave a talk on the ‘Renaissance of Value’*1, in which he said net-nets:
…gave such good results for us over a 40-year period of decision-making that we eventually denounced all other common-stock choices based on the usual valuation procedures, and concentrated on these sub-asset stocks.
He continued:
It seems no more than ordinary sense to conclude that if one can make up, say, a 30-stock portfolio of issues obtainable at less than working capital, and if these issues meet other value criteria, including the analysts’ belief that the enterprise has reasonably good long-term prospects, why not limit one’s selection to such issues…?
To ameliorate the risk of such unfancied companies going bust or at least remaining unfancied, Mr Graham would have diversified, and he’d have ensured they had reasonable prospects.
More recently, Mr Montier has quantified the risk and reward by testing the net-net strategy in global markets since 1985. It returned 37.5% a year versus a market return of 17%, but 5% of net-nets failed per year (fell in price by more than 90%) versus 2% for the market.
Sadly, our UK list of net-nets is not diverse, and I have doubts about 600…
Another of Mr Graham’s practices was to use the average of many years of earnings as an indicator of a company’s earnings power. Before 600’s strategic review in 2006, profits had been declining for years and the company recorded a loss in 2003. Since then it’s recovered slightly, but, had it not been for profits from its pension scheme, 600 would still have lost money in some years, and made marginal profits in others.
After six years of growth, 600 said the machine tools cycle was peaking last year and the reality of recession must surely confirm that. I’m not convinced 600 has earnings power.
Perhaps it’s too early to pronounce the ‘Renaissance of Value’ in the UK. But if the stockmarket’s recent performance is anything to go by, we’re getting there. 600 could be the swallow that heralds spring, albeit a bit of a lame one.
Footnotes:
- Reported in Barron’s, and republished in the excellent ‘The Rediscovered Benjamin Graham’. I warned you last week you’d be hearing more about it.
Comments
5 Responses to “‘Renaissance of Value’ postponed”
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Hi, I’m a value investor too.
I have been searching for bargain issues in Malaysian Stock Market (Bursa Malaysia) for years.
And I notice that very few stocks will ever being considered as “cheap” if we follow Ben Graham’s approach. Since he emphasized Net Tangible Assets Value.
May be it’s time for us to include intangible assets while researching the stocks.
Thanks for the article anyway.
http://investoger.tk
Hi Tai, thanks for your comment. Generally you’re right, but there have been times of extreme pessimism when people using Graham’s methods have had plenty of stocks to choose from. I’m interested to see if the current bear market becomes one of them. I think including intangibles breaks the logic because of they are of less certain value. You might as well just switch to another method of valuation or switch to special situations (as Graham did) when you can’t find true ‘bargains’.
Holders Technology ( HDT.L ) is a nice net net stock at the moment. The CEO owns just under 50% so guess who will try to avoid disaster at all costs…..let the CEO worry about it.
HDT may make a loss in H1 2009 but has recently introduced a new product line which has been received well.
HDT is very cash generative and if you buy before April 22nd you’ll get a final divi of around 4.8%
:O)
Hi Liarspoker, thanks for your comment. I wrote about HDT a couple of weeks ago: http://blog.iii.co.uk/holding-on-for-the-cycle-to-turn/
…and largely agree with you, though I am a bit concerned about the number of delistings because owner/managers see the opportunity to take the company private at a snip.
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