Net-net investing, a way that can be used to find some of the market’s cheapest bargains, was pioneered by Benjamin Graham, an influential and legendary figure in the world of investing. What sort of bargains might it be able to unearth in Singapore’s stock market? Understanding net-net investing But first, let’s understand what a net-net share is all about. A net-net share is one that has a market capitalisation lower than its net current asset value (the net current asset value in turn is determined by subtracting a company’s total liabilities from its current assets). If a net-net share liquidates…
Net-net investing, a way that can be used to find some of the market’s cheapest bargains, was pioneered by Benjamin Graham, an influential and legendary figure in the world of investing. What sort of bargains might it be able to unearth in Singapore’s stock market?
Understanding net-net investing
But first, let’s understand what a net-net share is all about. A net-net share is one that has a market capitalisation lower than its net current asset value (the net current asset value in turn is determined by subtracting a company’s total liabilities from its current assets).
If a net-net share liquidates its business, its current assets (things like cash on hand, inventory, and receivables from customers) could theoretically leave some left-over cash for its investors even after settling all its obligations.
Eagle-eyed readers might wonder: What about the company’s long-term assets, like its properties, factories, and equipment? That’s the best part about net-net investing. Investors buying into a net-net share are effectively getting a company’s long-term assets for free. In the meantime, these long-term assets are also likely to be able to fetch some value if liquidated.
It’s not all rainbows and sunshine…
But, the problem is that companies seldom liquidate their businesses. And this creates a risk for investors.
Net-net shares are often poor quality firms that are not able to grow the value of their businesses much, if at all, over the long-term – some might even be destroying value. If a net-net share is not liquidated, investors would have to depend on the market to realise that it has been making a mistake and then adjust its share price upward.
The longer the process takes, the lower the investor’s rate of return on the investment; for shares which are destroying value over time, the gap between its market cap and net current asset value might even disappear.
There are also other risks present with net-net shares in Singapore. Eratat Lifestyle Limited (SGX: FO8) is an example of a net-net share gone wrong.
In January 2014, Eratat’s shares were suspended from trading after it defaulted on its interest payments for a loan; the company was subsequently found to have massively overstated the amount of cash it has (an actual amount of RMB 73,000 versus the claim of RMB 577 million). In other words, the company had literally lied about the cash it had on its balance sheet.
Just prior to its suspension, the company had a market cap of RMB 224 million and a net current asset value of RMB 962 million. (It had in fact, been a net-net share since at least January 2012.)
Another net-net share, DMX Technologies Group Limited (SGX: 5CH) also ran into trouble in March 2015. The firm suspended the trading of its shares that month after reporting that authorities in Hong Kong (the company’s base of operations) had uncovered irregular accounting practices that had occurred in its subsidiaries in 2008 and 2009. Investigations are still ongoing and the share’s still suspended.
When the suspension happened, I noted that DMX Technologies had been a net-net share since at least the start of 2013 and that its valuation gap (the distance between its market cap and its net current asset value) had widened considerably over time.
Eratat and DMX Technologies had both been net-net shares that looked like attractive bargains for a few years (in the latter’s case, it even appeared to become a more enticing bargain with the passage of time). But as it turned out, both ended up being firms that had committed severe wrongdoings in their business dealings which decimated shareholder value when all was said and done.
The market may get things wrong at times, but there are also occasions when it’s prescient and is trying to warn investors of the dangers that may lurk in a certain share – like when it persistently awarded dirt-cheap valuations to both Eratat and DMX Technologies.
The bargain champions
With us having gone through the apparent attractiveness of net-net shares as well as their risks, it’s time to answer the question I posed at the start of the article: What sort of bargains might Graham’s net-net investing technique unearth in Singapore’s stock market?
Using data provided by S&P Capital IQ, here are the list of Singapore’s five cheapest shares as measured by how much higher their net current asset values are when compared with their market caps:
- Kingboard Copper Foil Holdings Limited (SGX: K14)
- Sing Holdings Limited (SGX: 5IC)
- Hengxin Technology Ltd (SGX: I85)
- Hanwell Holdings Ltd (SGX: DM0)
- Li Heng Chemical Fibre Technologies Limited (SGX: AXZ)
Their relevant financials are seen in the table below:
Source: S&P Capital IQ; data as of 7 June 2015
For some perspective on how cheap the quintet above appear to be, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund tracking the fundamentals of Singapore’s market barometer the Straits Times Index (SGX: ^STI) – has a market price that’s nearly 30% higher than its book value; in other words, its market cap is way higher than its net current value.
But like I’ve discussed earlier, a net-net share need not necessarily be a real bargain. Investors interested in the quintet need to dig deeper into issues like the integrity of their management teams and whether they are eroding the values of their businesses over time.
There’s another important thing worth pointing out. When Graham invested in net-net shares, he did so in a widely diversified manner because he knew each share could be rife with danger (be it from fraud or an erosion of value from inept management/a poor business environment) – it’s only when he owned a huge basket of such shares that the risks can be lowered substantially.
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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.