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, then 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 of a stock 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 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 UOB-Kay Hian Holdings Limited (SGX: U10). The firm is Singapore’s largest domestic broker based on the number of registered trading representatives employed. UOB-Kay Hian also provides wealth management services in Singapore and Hong Kong. Globally, it has around 2,960 professional and support staff.
A dive into the financials
The company’s revenue (including foreign exchange gain) had improved from S$369.6 million for the financial year ended 31 December 2014 (FY2014) to S$379.5 million in FY2017, giving an annualised increase of 0.9%. Profit attributable to shareholders had climbed at a slower rate during the same time frame – from S$74.4 million in FY2014 to S$76.2 million in FY2017 – at 0.8% per year.
The following shows the firm’s key financial highlights from FY2014 to FY2017:
Source: UOB-Kay Hian Holdings Limited 2017 annual report
As of 31 March 2018, UOB-Kay Hian had total current assets of S$3.358 billion, and total liabilities of S$1.995 billion. This gives a net current asset value of around S$1.363 billion.
At the current stock price of S$1.27, the stockbroker has a market capitalisation of S$1.024 billion. Therefore, the ratio of UOB-Kay Hian’s market-capitalisation-to-net-current-asset-value is 0.751 now. This also means the company is selling at an around 25% discount to its net current asset value.
The Foolish takeaway
Even though UOB-Kay Hian is a net-net stock right now, it does not mean that we have to gobble up its shares immediately. Not all net-net stocks work out well for an investor, and some will end up losing us money. Therefore, diversifying widely is critical in protecting our portfolio.
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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.