Richard Hemming July 13, 2012
It would seem that in the big caps at least, the secret to investing in the past three months would be to buy the nation’s telecommunications carrier, which is now trading at multi-year highs, having climbed about 15 per cent over this period, while the All Ordinaries has fallen 6 per cent.
But will it last?
The reason investors are flocking to Telstra is its yield, which even after the rise stands at just over 7 per cent. The market is in love with what it believes are earnings that are virtually Government backed (due to the $11 billion or so it’s receiving from taxpayers in the guise of NBN Co).
But many investors that have been around the block know that purchasing for yield alone is a folly that will almost certainly end in tears.
“One day there will be a reversion and that could be very painful,” says Geoff Wilson of Wilson Asset Management.
He points to the financial crisis when Telstra’s shares fell 35 per cent in nine months.
Benjamin Graham and Net Net, NTA
Far from looking at yield, investors would be wise to look at a company’s balance sheet, Wilson says. He is echoing the beliefs of one of the most famous investors, Benjamin Graham, whose “Net-Net” theory says a company is valued solely on its net current assets. Says Wilson:
“You have to buy on fundamentals. The easiest thing (for investors) is to look for companies trading at discounts to cash or to their NTA. They are the easiest ones to work out what they’re worth; the easiest to value.”
NTA refers to net tangible assets, which refers to the value of a company’s assets, excluding those that are intangible, such as intellectual property and goodwill, less the group’s debt. Goodwill is the excess over a company’s NTA that is paid by a purchaser.
If the company was sold tomorrow, the NTA is the most accurate figure of what would be given to shareholders.
Recently, Wilson has been buying Keybridge Capital (KBC), an investment company that previously borrowed money to invest in high yielding products. Wilson says his fund has been purchasing since Keybridge was 10 cents in June. It now trades at 13.5 cents, but still well below its NTA of 25 cents.
Greg Paramor says there’s more to life than NTA
Some are sceptical about the concept of NTA being the real value of a company. This week, property group Folkestone’s (FLK) shares bounced from 8 cents to 9.5 cents after it announced it intends to purchase the shares in Austock’s property funds management business for $11 million.
Because of the goodwill Folkstone is paying, its NTA, which was 12 cents, will come down, despite improving cash flows. Its chief executive Greg Paramor tells Under the Radar:
“This business is generating $5 million in gross fees, and the NTA goes down because of the goodwill. But that’s the vagaries of accounting. Our business will be valued on its earnings growth and growth in value of business.”
In Folkestone’s case Paramor says that earnings will be driven by its property funds management business, and from the properties it develops.
Low cash flow multiples
Carlos Gil, the founder of the specialist fund manager Microequities says that he doesn’t bother about NTA much, and spends his time trawling for companies trading on low cash flow or price earnings multiples. The ones he mentions are telecommunications junior Big Air (BGL) and mining services technology provider ISS (ISS):
“A number of companies are cheap, but not because of their NTA, but because of their future free cash flow.”
According to Gil, Big Air trades on 4 times next year’s operating profit, has no debt and a record of growth. While ISS should generate $3 million in profit this year, which means it’s trading on a PE of just over 5 times.
Under the Radar likes these stocks too. We’ve tipped both these companies, which have returned 48 per cent in ISS’s case and 16 per cent in Big Air’s.
There is more to life than an NTA, but it is still the most objective measure out there. Benjamin Graham knew this in the 1930s.
Richard Hemming is an independent analyst who edits the fortnightly undertheradarreport.com.au.
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