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19 May 2010
Building Asset Value
I thought I'd say a little something about how I decide to buy and sell companies, and what my rationale is behind each trade. There is some discretion involved, but not much, and this is certainly a fair summary of what I do. A simplified version of this is available on the Checklist page.
Let's say I start with £1000 in cash. I look for a company where I can pay £1000 for something worth at least £1,500. 'Worth' is a slippery term, but to me it means shareholder equity or book value, and I prefer tangible real assets to intangible assets. I realise that book value isn't always the actual net value of the company assets, what with 'cooking the books' and all. However, I don't have the time or interest in digging out all the details so I imagine that the good and bad net each other out. To be on the safe side I use a wide margin of safety.
So I head out into the market and find some companies where I can buy a pound fifty of book value for a pound. These companies are typically quite sick, often making losses, often unloved by almost everybody. Because they are often losing money they need to be able to weather their current problems. They need a bomb-proof balance sheet, or as near as can be. Typically this means they don't have a lot of debt and have at least fair liquidity.
Debt is often what gets a company killed. If the banks refuse to lend to a company which is dependent on debt it's game over and the companies I buy are not top of many banks lend-to lists. Debt can be measured in many ways, but I tend to use net gearing, which is gearing based on net debt, which is interest bearing debt minus cash and equivalents. What exactly is low debt is debatable and I don't have a hard rule, but certainly less than 100% of tangible equity.
Debt is often what gets a company killed. If the banks refuse to lend to a company which is dependent on debt it's game over and the companies I buy are not top of many banks lend-to lists. Debt can be measured in many ways, but I tend to use net gearing, which is gearing based on net debt, which is interest bearing debt minus cash and equivalents. What exactly is low debt is debatable and I don't have a hard rule, but certainly less than 100% of tangible equity.
And talking of getting out, if I can sell a company and turn its book value into cold hard cash then I will. Once the market price equals the book price I see no sense in hanging on. During my holding period the original £1,000 has turned into £1,500, perhaps with some small dividend paid out in the year or three I had to wait. Now I have £1,500 cash in my hands, so I go right back to the market looking for that pound fifty on sale for a pound, or in this case £2,250, at which point it all begins again.
As you can see, the focus is always very much on building up the total book value of my holdings. Of course, it isn't always a happy ending. Sometimes the managers manage to burn a big chunk of my book value up. Sometimes I wake up and the new annual report says my company is worth 30% less than it was yesterday and suddenly the market price is above book value. It might even be worth less than I paid for it. From here there are two courses of action. I can ignore the paper loss, turn a blind eye and say "I will only sell if I have a gain". But this is not logically consistent. It smacks of making up the rules as you go along and one of the keys to investing I think is to make up the rules and then stick to them! So what I should do - and have done so far on the one occasion it's happened - is to sell at a loss, try to work out where it all went wrong, swear at the management and start looking for the next unloved but robust company to back.
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7 comments:
Put that way, it seems very straightforward. Since we do something similar, I'll be watching your performance as a benchmark against mine!
Hi Richard
I think we exist in a pretty small corner of the investing universe so we're likely to keep tripping over the same companies. What I might do is comment on your posts where you review companies for the Thrifty 30 to see what I would make of that company. I suppose the main difference is I might invest in a company with worse historic earnings that you would, although I do give the last 5 or so years earnings a cursory glance (not that I understand EBITDA or whatever it is).
Hi UKVI
As you know I'm a little different to you and buy indices rather than individual stocks. I'm still looking for value though.
Starting to think ASX 200 might be approaching fair value. ASX 200 CAPE according to my analysis is down to 16.8 where I think fair value is around 16.4.
Not ready to buy yet as I'm also conscious of taxes. My Aus indices pay dividends at the end of June so to me it doesn't make sense to buy now only to be taxed on dividends almost immediately.
If the CAPE continues to come down into July I'll be having a serious look to add to my position.
PS: Hope the baby is doing well.
Thanks RIT, he's fine. Not sure what the correlation between Europe and Australia is but the way things are going it's probably getting cheaper by the day. Regarding taxes, I'm surprised you're not using some sort of tax efficient vehicle, ISA or SIPP for example, or is that to do with the fact that it's an international holding?
Hi UKVI
I'm definitely using tax efficient vehicles. Currently have about 9% of total assets in ISA, 33% in Pensions and 20% in Index Linked Savings Certificates.
Unfortunately though ISA and ILSC's have investment limits and I don't want all of my eggs in the Pension basket for obvious reasons. 1/3 suits me fine here.
This means I hold quite a lot of assets non-tax effectively. I do admit though that if I had have been smarter in my younger years I would have been more tax effectively invested but I only started to sort myself out in 2007.
Hi UKVI, please do comment - likewise I'll do the same when you invest. I like to think of myself as deep value and you as 'even deeper value'!
i think you're doing the right things because you've been told to do it that way but you don't know the proper way to go about it.
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