Poor Warren Buffett. The company he runs, Berkshire Hathaway, has over $37 billion sitting around in cash. But with a near-$200 billion market capitalisation, Buffett has to buy on a monumental scale to move the dial.
If Buffett could chuck me a billion or two, I think I could make him some money. That’s because various shares listed on the UK stock market are currently trading at a big discount to net asset value (NAV).
They might boast £100 million of assets after debt, for example, yet only be trading on a valuation of £70 million.
On the face of it, you’re being offered the chance to buy £1 coins for 70p. With a Buffett-sized warchest you could buy these companies outright, wind them up, and pocket the difference!
Well, it’s a nice theory. In reality there are costs involved with realising assets – perhaps as much as 5% of the NAV – and it can take a while, too. And when investing, time means money.
Also, if anyone got wind of Buffett or another deep-pocketed investor buying up such shares in a big way, the price would shoot up. Shareholdings above a certain size have to be declared, so there’s a limit to how sneaky you can be.
Finally, there are the takeover rules. Buy too many shares and you’re going to have to make a formal bid for the company. Again, that’s going to drive the price higher – perhaps too high to make your wind-up plan worth the bother.
You win if you’re right – but when?
So much for why Mr. Buffett isn’t shopping in London for bargains. You and I have different problems. We can put a few thousands pounds into an investment trust trading at a discount without so much as rippling the price.
Rather, that’s where our problems begin.
You might decide an investment trust or company deserves to trade closer to the underlying NAV of its holdings, but who’s listening? If Buffett bought in it would make headline news. When you buy in, nobody cares except your broker who enjoys the dealing fees, the taxman who gets his 0.5% stamp duty, and your partner who wonders where that £5,000 they’d earmarked for a new car went.
As a small investor buying into an ‘asset play’ like this, all you can do is plan for one of three outcomes:
- You win – You correctly identify an investment trust or similar company trading at an unwarranted discount to its NAV. Perhaps better results attract more attention, or perhaps an activist fund takes a stake and starts demanding the board make changes or even liquidates all its holdings and returns the cash to shareholders. Either way, the NAV stays firm or even increases while the discount gets smaller as the share price rises. On paper, you’re in profit.
- You lose – Perhaps the discount was warranted, after all. The market was right to be skeptical of the value of the property or investments or other assets that comprised the company’s NAV. Rather than the share price rising, the discount is closed as the NAV is written down. The share price likely falls, too,1 and you potentially make a loss.
- You wait – Often nothing happens. You keep holding the shares, maybe collecting a dividend for your troubles, while watching events unfold. You take a holiday. One of your children starts school. Sooner or later one of the above two scenarios happens, but you could be waiting years.
There is no easy money on offer in the stock market, and buying assets at a discount is no exception.
Asset plays aren’t easy money
If you pay 70p for assets worth £1 then something good is likely to happen, but there are no guarantees.
That said, I would wager that the ordinary person is likely to fair better with asset plays than, say, trying to outthink the analysts when it comes to the share price of Rolls Royce or Vodafone.
That’s because investment trusts clearly move in and out of favour, and fear and greed is easier to spot in the discount to NAV compared to a potential boost to Vodafone’s earnings that went unnoticed by dozens of professional analysts covering the stock, for example.
On the other hand, it’s mentally difficult buying into something other investors are clearly avoiding. For good reason, us human beings have evolved to do what other people do. Those who charged on regardless tended to run off cliffs, got eaten by lions, or poisoned themselves by feasting on rotting food.
Is the opportunity you’ve spotted a gold mine or a mineshaft? Only you can make that decision if you go down this road, and you must live with the consequences.
Such is the lot of an active investor.
- Note that the share price might not fall. For example, a new CEO could come in and order a revaluation of assets that restores confidence in the NAV, but at a lower level than before. It might still be higher than the price you paid for the shares, however. [↩]
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Corporate raiders seemed to do quite well in the 1980s when many stocks were undervalued. Hostile takeovers seem rare these days though,
I think the problem with buying for asset value is what is on a balance sheet is very different from the realisable value of assets. R&D and brand costs are charged to the P&L, fixed assets often have a lower market value than accounting residual value, other stakeholders have an interest in assets and current assets often depreciate in value quickly.
@Dave — Agreed, but the examples I’m thinking of are mainly marketable or listed securities. In one case it’s all cash! I’ll share some ideas in the next few days if anyone’s interested? 🙂
I’ve done this a few times with some nice big winners (RIT Capital, Dresdner Endowment, Electra, Alliance Trust, Graphite Capital and Dunedin Enterprise) and some dog losers (Close Bros IT capital shares, Govett Oriental and F&C Emerging Markets)
The one thing I’d say is you really need to look at a few sets of accounts and figure out if something is
– cheap because its out of fashion, e.g. unmarketed and unheard of or just an asset class everyone hates right now, e.g. private equity and smaller UK companies
– cheap for a reason, e.g. because it has some funny assets on the balance sheet, too expensive debt (some trusts have double digit interest rate fixed interest long term loans still) and its also not impossible the directors are just crooks in small trusts
– the amount of leverage the trust or the investments it owns have, for instance private equity trusts and property trusts often have more loans behind them than equity, which is good on the way up and bad on the way down
Eventually over a five period its often the case that the valuation anomally (sp?) gets noticed and sorted out either by the board or an external agitator
But you should only be willing to put funds in that you don’t need for a decade into this type of thing, because it might well be a longer haul than you think and you also need to be vigilant enough to sell when the going is good, sticking around for the long term in leveraged or volatile investments prone to bubbles is not actually a winning strategy all the time
So long as there is no dilution in the air that will lock in a low price its a nice idea that you should be able to do nicely with such a strategy after much practice. You just need to decide whether to do a Ben Graham (and buy up the cigar buts and cash in when you can) or a Phil Fisher (and buy cheap growth stocks and hold forever).
@Neverland — Great additional insights, thanks. Be interested to get your views on my ideas if I post them up next week.
@Rob — Asset plays are very much in the Ben Graham school of business. That said, you might continue to hold afterwards because you like the company (as I have done with RIT Capital Partners).
@ Investor
Oh go on then
PS. Did you see MoneySavingExpert.com got sold for £87m? Maybe you should start a forum…
@Neverland – Hah, I think Martin Lewis beat me to that idea. 😉 I would consider starting one, but the policing of it to try to avoid people getting ripped off / ramping shares etc would be a huge headache and I really don’t want to be contributing to the misinformation and sniping on the Internet. But it’s not a bad suggestion, and it comes in and out of mind, depending on how snowed under I am with work in any week and how positive and useful comments have been that week. (Generally Monevator readers are overwhelmingly friendly, and helpful and respectful to each other! 🙂 ).
There are a fair number of investment companies in wind up mode at the moment. This gives the advantage of a calculable potential return based on the published NAV and expected time frame. Of course, some assets are more easily realised than others.
@Soicowboy — Very true, Gresham House IT is one such on my list that I’ll be referencing next week. 🙂
You’re not wrong. It certainly does take nerves of steal. I always head into value plays with 100% confidence. I’m in the middle of a couple now and I’m…well, less confident 🙂 But at least it’s fun!