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Investors Beware: Very Cheap “Value Shares” Can Destroy Your Capital Too

Earlier today, I chanced upon an interesting post made by a member of an internet forum that’s dedicated to Singapore’s stock market.

Part of his post talked about how since listed companies in Singapore are audited by reputable firms, the value of a share’s net tangible assets (more on this accounting term later) should be believable.

The member then mentioned how investors who sell shares which are trading for below their net tangible assets must be in need of money.

The implicit assumption behind his post is likely to be this: Since a share which is selling for less than its net tangible assets is a huge bargain on the surface, it wouldn’t make sense for an investor to discard such shares unless there’s a real emergency.

I find this to be a real dangerous misconception because such shares need not be bargains at all. But first, here’s a quick dive into what “net tangible assets” mean.

The nitty-gritty of assets

Every company would have, on its balance sheet, assets (what the firm owns) and liabilities (what the firm owes). The difference between the two figures would be known as net assets.

Any company’s assets would include tangible items like cold hard cash, inventory, properties, factories, and so on. It would also include the intangibles like say intellectual property or goodwill.

If we now strip the value of intangible assets off from a company’s net assets, what we’re left with is the firm’s net tangible assets.

Finding value

When we have a company selling for a price lower than its net tangible assets, it would appear that we’re getting a real bargain – if the company’s liquidated there and then, we’d still be left with cash after selling off all the assets and paying off all obligations.

That’s true, theoretically. But in practice, companies are seldom liquidated. And this is where a problem can arise.

While a share may be a temporary bargain when its price dips below its net tangible assets, companies can – and sometimes do – steadily burn away their net tangible assets. For such companies, the underlying intrinsic value found within their shares would be chipped away over time.

An ignominious group

The quartet of First Ship Lease Trust (SGX: D8DU), Indiabulls Properties Investment Trust (SGX: F3EU), Mercator Lines (Singapore) Ltd (SGX: EE6), and Rickmers Maritime (SGX: B1ZU) would belong to an ignominious group of shares which have seen their net tangible assets decline over the past two years.

Shares selling below net tangible assets

Source: S&P Capital IQ

And as you can see in the table above, all four companies have seen declines in their share prices over the past two years. What’s also interesting here is that the quartet were all trading below their net tangible assets on 20 March 2013.

Their low valuations back then couldn’t save them as their businesses had subsequently turned in terrible results.

A Fool’s take

Looking for shares which are selling for lower than their net tangible assets might be a good way to find cheap bargains. But it pays to note as well that there are cases where what looks cheap can still turn out to be expensive mistakes too.

There are currently more than 150 shares in our stock market here which are selling for lower than their net tangible assets but which have also seen their net tangible assets decline over the past two years.

Some of them might be legitimate bargains. But, investors would have to tread carefully in that space.

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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 company mentioned.