Yesterday, I explained the power of value investing.
I told you the story of how one American couple was able to buy a large private road in a wealthy neighborhood from the San Francisco city government for just US$90,100.
The couple knew this road was undervalued… and that they could generate recurring income from it. (As it happened, the sale was overturned due to politics.)
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These are the types of real-life situations where money is just lying in the corner, waiting for someone to pick it up.
So how do you find these situations in the stock market? In my mind the best way is to…
Look for profitable companies that trade below their net tangible value
One of the worst things you can do as an investor is to jump into a stock without knowing what the company is worth relative to the price you’re paying.
After all, you wouldn’t buy a new house without finding out the average price of homes in the neighbourhood, and if there were any good schools, hospitals, supermarkets or churches nearby. That’s the most basic and essential kind of due diligence.
But too often, investors don’t look under the hood of a company before clicking “buy”.
So before you buy a stock… consider the question, “If this company were to go out of business today, what will I be left with as an investor?”
To answer that question, you need to look at the company’s balance sheet to determine a company’s net tangible value.
Net tangible value is a company’s assets (that is cash, property, inventory and accounts receivables), after deducting its intangible assets (i.e., goodwill, trademarks, patents, etc.), as well as all of its liabilities (that is, everything it owes to others – all debt, future payments due and anything else).
You want to find out what will the company be left with if it sold off all its physical assets, and paid off all its liabilities. (Even though a company’s patents and other intangibles may be worth something, it’s difficult for me – as a third party – to figure out how much… and in any case, selling them might take time. So it’s easier to assume that they’re not worth anything to me, as a portfolio investor.)
If your net tangible value is a lot lower than the current market value, look elsewhere.
(That’s unless it has a monopoly on its industry, has a major advantage over its competitors or it’s about to launch a product that will turn its industry on its head. These types of companies tend to trade above their net tangible asset value because of the premium their unique industry situation gives them.
For instance, Coca-Cola, which enjoys a near-monopolistic situation in most markets it operates in, trades at hundreds of times its net tangible value. Its brand, and its recipe, are enormously valuable… and that’s what you’re paying for as an investor.)
But there are times when you can find a terrific company that’s undeservingly trading significantly below its net tangible value.
My “money in the corner” moment
In August 2016, I discovered a little Hong Kong-traded company called Ming Fai International (Exchange: Hong Kong; ticker: 3828). It was in the unglamorous business of supplying hotels around the world with the tiny bottles of shampoo, lotions and conditioners given away for free in bathrooms.
Nothing about the company would make for exciting party conversation.
A deeper look into its accounts revealed it had US$209 million in tangible assets, and just US$78.7 million in total liabilities.
So its net tangible value was US$130.3 million.
Yet, its market capitalisation (that is, the value of the company calculated by taking the number of outstanding shares and multiplying it by the share price) was only US$94 million.
In short, this profitable company was selling for 28 percent below its net tangible asset value. That means that, in theory, I could pocket a 38 percent profit by buying the entire company and selling off all its assets and paying off its liabilities.
And part of its assets included prime office units in the heart of Hong Kong’s financial district – worth US$34 million in the market. Management was looking to sell these units since they weren’t using them, and they could book a tidy profit, given the price had already doubled from their purchase cost.
- Current total market cap: US$60 billion
- 2025 industry forecast: US$1.2 trillion
That would amount to an extraordinary 2,000% increase in the value of this market over the next 7 years.
Even better, the company was only valuing this property at US$27 million on its books. There was a big potential for Ming Fai’s net tangible asset value to get a nice bump up after they sold this property.
I knew the Hong Kong property market was heating up, and this prime property would go quickly. And because Ming Fai was already generating positive cash from its strong business, it didn’t need the excess money and would likely distribute the proceeds from the sale as dividends.
So I recommended that my readers take a position.
That very same month, Ming Fai sold its investment in these offices, and declared it would pay out a one-time dividend worth nearly 20 percent of the price where the stock was trading when I first discovered the company.
This dividend was the catalyst that garnered investors’ attention.
By May of the following year, the shares had resulted in a 48 percent total return, including dividends. I didn’t recommend selling even though shares have drifted a bit lower, because Ming Fai continues to generate strong earnings from its business, and has been paying out 6 percent dividends.
That’s the power of value investing.
Always think of safety
When you buy shares in good companies below their net tangible value, you have a margin of safety.
In the case of Ming Fai, it was a 28 percent margin of safety. That effectively meant I could theoretically sell off all its assets and pay off all liabilities… and still be left with a good chunk of money.
But not all companies trading at discounts to their net tangible assets are worth investing in. Some are trading at a discount for a reason. Either something is wrong with management, their business outlook is deteriorating, or they’re losing money. That’s the importance of research.
And only buy when you’re absolutely convinced that the company is mispriced and underappreciated by the market. Then you just have to wait for the next guy to find out what you already know.
Editor, Stansberry Churchouse Research
P.S. Earlier this month, we held our Asia Opportunities Conference in Hong Kong, with a powerhouse lineup of guest speakers, including Tama Churchouse…Trend expert Michael Covel… Asia investment legend Peter Churchouse, Steve Sjuggerud, Kim Iskyan and me. And we put together a full video package – including the original presentations. The day was jam-packed with great insights on the Asian markets and key investment themes now taking center stage in the global markets, along with some terrific recommendations on how to invest in these interesting times. Just click here to see how you can access it.