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1 Big Problem with Buying Dirt-Cheap Shares

Credit: hobvias sudoneighm

Yesterday, The Business Times reported that DMX Technologies Group Limited (SGX: 5CH) had suspended the trading of its shares after authorities in Hong Kong had recently uncovered “irregular accounting practices” at two of the firm’s subsidiaries in 2008 and 2009; DMX is headquartered in the territory.

This comes after the arrest of both the firm’s chief executive officer and chief financial officer by the Hong Kong police early last month; both are currently released on bail.

While it’s still uncertain as to what would eventually happen to DMX Technologies and its business – the company has also requested for an extension to announce its results for 2014 and it’s not known if the “irregular accounting practices” that were revealed would have any impact on the firm’s financials – shareholders might want to prepare themselves for some possible pain ahead.

A bargain that isn’t

Investors who were out searching for dirt-cheap bargains in Singapore’s stock market over the past two years might have come across DMX Technologies.

Since the start of 2013, and possibly before, the firm had been trading below its net current value (total current assets minus total liabilities). You can see this in the chart below:

DMX Technologies' share price and net current asset value (NCAV) from the start of 2013 to 20 March 2015

Source: S&P Capital IQ

When a share sells for lower than its net current assets, investors are essentially getting a discount on current assets (cash, short-term investments, inventories, and receivables) net of all obligations.

In addition, the share’s fixed assets (like factories, equipment, and real estate) are thrown in for free. It thus follows that such shares could possibly be real cheap bargains.

When a share’s cheapness is too good to be true

But, the interesting thing about DMX Technologies’ experience is that its valuation was stuck at a really low level for an extended period of time (as the chart above shows, the valuation gap was even widening as time went on); it’s as though the market had been fearful of the proverbial cockroaches in DMX Technologies’ kitchen.

For me, the situation illustrates something important about the stock market: While it can get things wrong at times, shares that are somehow awarded dirt-cheap valuations for extended periods of time could possibly be ticking time-bombs, either due to a dying business or something more nefarious.

And, that’s the problem that investors can face when buying dirt-cheap shares: You never know when you’d be getting a time bomb.

Currently, there are 109 shares in Singapore which are selling for lower than their net current asset values.

The five shares with the highest market capitalisations within that bunch are, in descending order, China New Town Development Co Ltd (SGX: D4N), Hong Leong Asia Ltd (SGX: H22), Li Heng Chemical Fibre Technologies Ltd (SGX: E9A), Hanwell Holdings Ltd (SGX: DM0), and interestingly, DMX Technologies.

Shares selling below their net current asset values

Source: S&P Capital IQ

There might be legitimate bargains amongst that group of 109 shares. But keeping in mind DMX Technologies’ current predicament, bargain hunters might want to tread with caution 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.