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This Undervalued Stock Has A Huge Stake In One Of The 30 Best Stocks To Own In Singapore For 2018

One way to determine if a stock is undervalued is to compare its market capitalisation with its net current asset value.

If the market capitalisation of a stock is lower than its net current asset value, it could be undervalued. Such shares are known as net-nets. The father of value investing, Benjamin Graham, liked to invest in net-net stocks.

The net current asset value can be calculated using the following formula:

Net current asset value = Total current assets – Total liabilities

In theory, a net-net stock is a bargain as investors can get a discount on the company’s current assets, such as cash, after stripping off all liabilities. Moreover, the company’s fixed assets, such as properties, are thrown into the mix for free.

Having said that, net-net stocks are usually businesses that are in serious trouble and/or have poor business fundamentals. This means that investors who invest in these companies are also at risk of losing their capital if things continue going south.

One net-net stock in the Singapore stock market currently is Hanwell Holdings Ltd (SGX: DM0). As a quick background, Hanwell has two business clusters: Consumer essentials and strategic investments.

Under the consumer essentials arm, Hanwell distributes fast moving consumer goods such as the Royal Umbrella and Golden Peony brands of rice, and Beautex tissue products. The division also provides healthcare consultancy services.

Coming to the strategic investments cluster, Hanwell has a 64% stake (as of 13 March 2017) in Tat Seng Packaging Group Ltd (SGX: T12), one of the 30 stocks in Singapore’s market that scored very highly on the Magic Formula method of ranking stocks near the start of the year. My colleague, Chong Ser Jing, shared more about the Magic Formula and the 30 stocks in his recent article, The 30 Best Stocks In Singapore For 2018. I had also taken a deeper look into Tat Seng Packaging’s business in a separate article found here.

For the year ended 31 December 2017, Hanwell grew its revenue by 16% year-on-year to S$464 million while its bottom-line improved by 7.8% to S$11.1 million.

The higher revenue for the year was mainly due to a stronger performance at Tat Seng Packaging, especially from its China operations, which saw revenue growth of 35.9%. Tat Seng Packaging’s China subsidiaries raised their selling prices, especially for sales of corrugated boards, and passed on higher raw material costs to their customers (this is a trait known as pricing power, which billionaire investor Warren Buffett likes in his investments).

The aforementioned contributors to Hanwell’s top-line growth were partially offset by the closure of all franchise outlets from the company’s consumer business in Singapore.

As of 31 December 2017, Hanwell had total current assets of S$412.2 million and total liabilities of S$202.2 million. This gives a net current asset value of S$210 million. Last Friday, Hanwell’s stock price closed at S$0.22, translating to a market capitalisation of around S$122 million. The ratio of its market-capitalisation-to-net-current-asset-value is, therefore, 0.58. This also means the company is selling at a 42% discount to its net current asset value.

The Foolish bottom line

Even though Hanwell is a net-net stock currently, it does not mean that we have to gobble up its shares right now. Not all net-net stocks work out well for investors, and some might even end up losing you money. It’s important to also consider the company’s ability to maintain, or even grow, its net current asset value. And remember, diversifying widely is critical in protecting our portfolio when it comes to investing in net-net stocks.

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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 contributor Sudhan P doesn’t own shares in any companies mentioned.