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Are These Shares Good Value?

Value investing is a term that’s often bandied around when investors talk about the stock market. Its idea is simple: Be on the lookout for companies with market prices that are below its intrinsic value (i.e. the ‘true’ worth of a company based on its assets and economic characteristics).

While billionaire investor Warren Buffett might be the name that’s most closely associated with value investing these days, it was actually Buffett’s mentor, Benjamin Graham, who is widely considered to be the intellectual father of said investing philosophy.

Back in the day, Graham ran his own fund from 1936 to 1956 with great success, posting annualised returns of around 20%, way ahead of the American stock market’s return of around 12.2% per year in the same time period. With such returns, every $1,000 entrusted to Graham in 1936 would have become slightly more than $38,0000 by 1956. Meanwhile, the same amount invested in the American stock market would have turned into ‘only’ $10,000.

Buffett’s more well-known in modern times for investing in quality companies. But, many might not be familiar with the fact that Graham had an almost completely-opposite modus operandi.

Graham was famous for pioneering an investment approach known as the Net-net that he used extensively at his fund. It can be boiled down to a simple formula where the required figures can be easily gleaned from a share’s balance sheet:

Net-net = Current Assets – Total Liabilities

To Graham, intrinsic value was found in a share’s assets and he wanted to look for shares that had market prices at least two-thirds below its Net-net value.

That’s because he believed that a share that’s selling at such absurdly low prices (shares that were being sold below their Net-net values are essentially worth more dead than alive) would have provided him with a great margin of safety for error. At the same time, the low share price would have allowed him to participate in a nice surge in prices if the market’s pessimism toward such shares would start to fade a little. All told, Graham wanted cheap companies (which almost always happened to be ‘ugly’ and despised companies). Quality just wasn’t that important to him.

It was a really neat idea that worked for a long time (judging from Graham’s track record). However, the much faster flow of investing information today has dramatically reduced the number of such opportunities available.

Given this back-drop, are there any such shares to be found in Singapore’s stock market? I had relaxed the criteria to include shares that were selling below its Net-net value, regardless of whether it passed Graham’s two-third rule. And yet, the numbers were small.

I ran my modified Net-net screen on around 300 companies listed here, and though it’s not a complete sample (there are 800 publicly-listed companies in Singapore), there were only 16 shares that passed the screen.

Not surprisingly, there were no Net-nets at all among the 30 blue chips within the Straits Times Index (SGX: ^STI). Those 16 shares were companies with tiny market capitalisations ranging from S$231 million to just S$5.5 million.

The following five shares are the ones with market capitalisations that make up the lowest percentage of their Net-net value: Fujian Zhenyun Plastics Industry (SGX: 5KT), China Yongsheng (SGX: 5KK), Brooke Asia (SGX: 5OY), Sing Holdings (SGX: 5IC), DMX Technologies (SGX: 5CH).

Company

Net-net*

Market Capitalisation*

% of Market Cap as Net-net

Fujian Zhenyun

S$115 million

S$19 million

16%

China Yongsheng

S$46 million

S$20 million

44%

Brooke Asia

S$89 million

S$41 million

46%

Sing Holdings

S$264 million

S$144 million

55%

DMX Technologies

S$418 million

S$231 million

55%

Source: S&P Capital IQ; *Net-net and Market Capitalisation values as of 21 Feb 2014

So, looking at the table, do these shares look like good values and are they necessarily a buy? Not so fast. Companies selling at prices low enough to be able to pass the Net-net screen are usually facing difficulties of one sort or another.

For instance DMX Technologies, an information technology provider, has burned through a total of S$19 million in cash from its daily operations over its last five completed financial years. Elsewhere, Sing Holdings hasn’t been able to produce positive operating cash flow since 2011 while China Yongsheng has made losses in two of its last five financial years.

In a nutshell, companies that could pass through the Net-net screen are likely to be ones that are facing large operational difficulties or that might carry very high business risks. It’s certainly not a perfect investing technique – and there’re no perfect techniques – so tread carefully if you plan to use it.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.