Methods of Determining Value

The following outline the general methods in which I look for value in the market

1) Adjusted Book Value

As the term suggests, this is more than looking at the "shareholder's equity" value of the balance sheet, and taking into what the account that some assets are more reliable than others.

In a bullish market, an investment portfolio that consist of stocks in vogue (such as Perfect Medical's investment in tech stocks) should be adjusted downwards. Obviously you have to make a judgement call. Likewise, it might be prudent to be skeptical with property valuation which are based on level 3 inputs, or those based on a very low capitalization rate. More so, such valuation are less trustworthy if they were valued by the same company over an entire decade.

(cap rate = rental / property valuation; hence if rental does not change over the years, this would suggest that valuation has gone up, which can be unreliable). 

Good will will classically be adjusted downwards to zero by most geriatric investors (like myself). 

A note about non-interest bearing liabilities, such as payables. Always remember that account payables should be adequately covered by account receivables. Inventories should be revised aggressively downwards unless appreciation over time is possible (luxury watches, for e.g.). 

Look for an increasing net current assets throughout the years-- it is usually a sign of an attractive company.

This is, by far, my favourite.

2) Heavy Insider Buying

Between salaried employees and majority shareholders, I would certainly prefer that salaried employees be the ones buying stock, and that of reasonably large sums. I recalled before the ship sunk for Noble (the commodities trading company in Singapore), the owner was buying huge chunks of shares. Owners can be irrational.

Unfortunately, this could be the same case as one of my major holdings (Central China Real Estate Holdings), so I do feel uncomfortable writing this.

Company share buybacks are less convincing than directors buying stock out of their own pockets. Shares, from the former, could be willfully used for employee share option schemes, instead of cancellation.

3) Low PE adjusted for cyclicality

Within the category of  price to earnings, one could argue that Company A is trading lower than its peers in an industry group. This falls under what I call "relatively undervalued," which is one of my least favorite kind of valuation. For instance, company A could be selling at 20 times earnings and deem cheap, if most of its peers are selling at 40. Obviously 40 is high number, and 20 is not modest.

If you were to find companies that fit John Neff's criteria, in the area of neglected growth, that is even better. Neff have this beautiful simple formula which takes growth in earnings (as a percentage) + dividend and divide the sum by its PE. Comparing this with the index, it does reveal bargains. But I am not a fan of this approach and I do not use it as it is too complicated for me.

Generally I am not a fan of using earnings.

4) Troubled stocks selling at a low free cash flow multiple

This is one of my favourite categories-- of course not all companies could generate consistent cash flows. I use an average of multiple years of cash flow, against the market cap, as a gauge of bargain. Unfortunately, there is always some kind of trouble involving these companies, and holding them takes a lot of heart and patience.

(The following are what some call 'special situations')

5) Restructuring

A company consisting of different business segments may choose to rid itself of the underperforming ones. For instance, a company dealing with a loss-making student hostel accommodation, and a very profitable foreign worker lodging arm, could choose to sell off the student hostel business. This would result in better earnings in the end, and is likely to cause the share price to appreciate.

This is one way how a loss-making company could outperform a profitable one.

6) IPO/ Spin-offs

This does not refer to the typical IPO which happens very often when the market is frothy. I am referring to perhaps, company A, who has a huge chunk of stock in B, which is going public through the form of an IPO. 

Generally, an IPO underwriter try to serve two parties of interest-- the owner, which wants the price as high as possible; and itself, who wants to set a price modest enough so that price appreciation is possible. The latter is much less probable these days. 

Spin offs refer to companies who wish the list a subsidiary, by distributing shares to existing share holders of the parent. The main motivation of such an act is to reward management in the spin-off, or to improve the financial conditions of either the parent or the spin off. Sometimes a spin off could be used to highlight how undervalued the parent is, usually when view from a "sums of the part" perspective. 

7) Going Private Situations

When a company decides to de-list, it would usually have a reasonable amount of success by offering a respectable premium over its last transacted price, or book value.

By offering this premium, most existing shareholders will cash out so as to avoid the pain of watching the price fall back to pre-announcement levels. On the other hand, arbitrageurs, or parties acting in concert with management, would hold on and vote favorably to de-list.

On the flip side, when deals fall apart, and the price do fall back to pre-announcement levels, it might be wise to accumulate some shares. I have two reasons why this might be ideal: 1st, the pre-announcement price is likely reasonably modest, or else why would there be interest for a de-listing? 2nd, the interested party is likely to try again sometime in the future.

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There are other niche areas, such as distress investing, bond buying, price arbitraging; but these means are far too complicated for myself and hence not practiced.