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 [1] 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 [2].
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 [3] 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 [4] 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 [5] 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 [6], 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. [↩ [11]]