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 stocks 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 and 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 now is Cortina Holdings Limited (SGX: C41). The firm is a luxury watch retailer that began operations in 1972. It now has a presence in Singapore, Malaysia, Thailand, Indonesia, Hong Kong, and Taiwan.
A dive into the financials
For the fiscal year ended 31 March 2018 (FY2018), Cortina posted revenue of S$466.3 million, which grew 19% year-on-year. Meanwhile, its net profit surged 89% to S$22.3 million. The better showing was primarily due to the higher revenue and better sales margin.
Cash flow from operations went up by 56.1% year-on-year to S$55.5 million. With capital expenditure of S$6.0 million in FY2018, free cash flow jumped by around 71% to S$49.5 million, as compared to S$28.9 million in FY2017.
As for its outlook, Cortina commented:
“The global economy remains volatile and may continue to pose challenges to the Group’s performance in the years ahead. On the other hand, the purchasing power of the regional consumers is rising continually. The Group will continue to review and fine tune its strategies, adapt to the changes and emerging trends in the industry and in the markets that it operates in. Barring unforeseen circumstances, the Group will remain profitable.”
As of 31 March 2018, Cortina had total current assets of S$232.3 million, and total liabilities of S$72.9 million. This gives the firm a net current asset value of S$159.4 million.
At its last traded stock price of S$0.885 on 27 June 2018, the luxury watch retailer had a market capitalisation of S$146.5 million. The ratio of its market-capitalisation-to-net-current-asset-value is thus 0.92. This also means the company is selling at an 8.1% discount to its net current asset value.
The Foolish takeaway
Even though Cortina is a net-net stock right now, it does not mean that you must gobble up its shares once the stock market opens on Monday. Not all net-net stocks work out well for an investor, and some will end up losing you money. Therefore, diversifying widely is critical in protecting your 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.