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1 Big Bargain Stock That Actually Hides Huge Risks

On the surface, precision metal components manufacturer InnoTek Ltd (SGX: M14) looks like it’s a big bargain in the stock market.

At its current share price of S$0.155, the company has a market capitalisation of S$34.7 million, which is lower than its net current asset value of S$45.9 million.

The net current asset value of a stock is found by subtracting its total liabilities from its current assets. If a stock has a market capitalisation that’s lower than its net current asset value, it’s said to be a net-net stock.

InnoTek's NCAV table
Source: S&P Global Market Intelligence

In theory, a net-net stock is a huge bargain. That’s because investors are able to get a discount on the company’s current assets (assets such as cash, financial investments, and inventory) net of all liabilities. On top of that, the company’s fixed assets (assets such as properties and factories) are thrown into the mix for free.

But, net-net stocks can carry significant risks at times. For instance, companies that become net-net stocks often have businesses that are in deep trouble. This makes sense – a company with a thriving business would not carry such a low valuation except for in the rarest of circumstances.

InnoTek looks like a company that’s in trouble. Over the past few years from 2011 to 2015, it has made a profit in only two years. What’s more, it had made a cumulative loss of S$61.5 million in that block of time.

InnoTek's profit table
Source: S&P Global Market Intelligence

To compound the problem, the company has also struggled with generating positive operating cash flow from its business as the table below illustrates:

InnoTek's operating cash flow table
Source: S&P Global Market Intelligence

InnoTek’s struggles with generating a profit and positive operating cash flow should not be seen as signs that the company will definitely be a lousy investment going forward. To Innotek’s credit, it commented in its latest earnings release (for the first-quarter of 2016) that it “expects its performance for the whole of FY2016 to improve upon that of FY2015.”

But, investors would also have to be very mindful of the company’s longer-term track record and assess its ability to improve its business fortunes on a more sustainable basis. As it stands, the company’s losses and propensity to burn cash are huge risks to note.

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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.