This article was originally published here in Ju 2002
In my last article I showed the theory behind the way "value" investors use the balance sheet in a company’s report to determine whether it is worth buying shares in that company. Value investors are looking for companies they feel have a fundamental value greater than the value the stockmarket places on those companies. Value investors buy the shares and wait for the stockmarket to place a higher value on the company. Value shares often pay large dividends, which can make the waiting profitable in itself.
I have written a computer program that queries data sources available on the Internet to find potential value share investments. The program can select shares based on any criteria I choose. My favourite is to list shares that have shown rising Earnings Per Share over the past few years and yet have a Price to Tangible Book ratio less than one and a half. This list often contains hotel and property companies trading well below their book value. The market tends to place low values on these companies, as profits are a small percentage of the huge sums of money locked up in the balance sheet representing the property they own.
Last June I noticed Thistle Hotels had a share price of 120p, giving it a Price to Tangible Book Value ratio of roughly 0.55. Other similar hotel companies were trading with P/TBV ratios around 0.7. Studying Thistle’s company news and annual report I could find no good reason for such a discrepancy. I bought a few thousand shares and sat back to await developments.
Over the next few months the shares had nudged up a bit but then came September 11th. Share prices across the entire hotel sector fell sharply with Thistle hitting a low of 80p in early October. By January they had recovered back to the 120p I paid for them. In March the company announced that it had sold part of its hotel chain for its book value. This converted assets from a form the stockmarket does not like (property) into a form it loves (cash). The share price rose and I sold near the peak at 145p: A profit of over 10% in 10 months and a dividend of 1.7p a share as a bonus. Nothing special but nice considering the performance of the stockmarket as a whole.
When I ran my filter at Christmas one non-property company leapt out as having a very low P/TBV. This was Johnston Group, which does three things: quarrying, building products and specialty vehicles (fire engines and road sweepers for example). I started looking into the company and discovered the price had fallen sharply in response to a profit warning on the 20th of December. I decided not to spend any more time on the company but added it to my watch list of shares. Over the next few months I watched it rising from 210p up to 280p. Not so nice.
Following the release of Johnston’s full year results on the 27th March the price slid back down to 230p. I used the balance sheet to calculate the Net Tangible Assets.
The sum is:
Good Assets = Tangible assets + Stocks + Debtors + Cash = 30,934 + 26,657 + 26,584 + 4,522 = £88,697
Bad Assets = Short term creditors + Long term creditors + Provisions = 29,504 + 8,331 + 2,126 = £39,961
Net Tangible Assets = Good Assets - Bad Assets = £48,736.
Note that the figures are in thousands so Johnston Group had £48.7 million in Tangible Assets. Note 3 to the accounts (right at the end) tells us there are 10.8 million shares in issue. At a price of 230p per share the company is valued at just under £25 million. We can calculate the Price to Tangible Book ratio as 25 / 48.7 = 0.51. Johnston group’s shares were on sale for half their book value. As the assets consisted largely of big holes in the ground (the quarries) it is doubtful the share price would ever reflect the asset value.
However, the annual report had other things to commend Johnston Group. The company was still making a profit (£3.8 million, down from £9.2 million the year before). The directors were maintaining the dividend of 13.75p (a yield of nearly 6% with the share price at 230p). Debt was low, the profit and loss account shows interest charges of £645,000, well covered by the profits. Finally, the Chairman’s statement seemed quite positive about prospects for the next year.
On the strength of all of this I bought one thousand shares for 235p on the 5th of April. The price started to rise. On May 15th there was a sudden leap up in the price and I sold out at 316p a share. Since there the price has risen slightly higher. Still, a gain of 35% in just over a month is not too bad.
I hope I have shown how easy it can be to make money from value investing. The stockmarket does price shares wrongly. Used carefully the Price to Tangible Book Value ratio is a powerful tool for finding under priced companies and profiting from their rise.