I see that there is much discussions over my value trap post. To "muddy" the water a bit, I have another value trap challenge.
The Graham Net Net is a valuation metrics used by Graham and Warren Buffett (when he first started out). It is derived by deducting total liabilities from the current assets. Many consider this a proxy for the liquidation value. So when you have a stock trading below its Net Current Asset value it is supposedly a good margin of safety.
Eksons is a Bursa plywood company with a property segment. Its plywood business got into trouble years ago with its log supply and it is still trying to get this business to turnaround. The Malaysian property sector got soft some time in 2016/17 and is probably at the bottom a year or two ago.
The Chart below shows the valuation of Eksons over the past 8 years based on its Price to Net Current Asset value. A ratio of less than 1 meant that it is a Graham Net Net. You can see it being a Net Net from 2015.
![[Image: Eksons-value-c-w-performance.png]](https://i.postimg.cc/5NsPb8JR/Eksons-value-c-w-performance.png)
Unfortunately its performance as indicated by the EBITDA during the past 8 years were terrible. But is was a "steady" loss and not a declining one.
Based on the Graham Net Net, there is a margin of safety. We know that it is cheap because of the problems with the plywood and property businesses. But the "liquidation value" is higher than the stock price.
So is this a value trap or a bargain?
PS: To be transparent, I bought Eksons years ago on the basis of it being a Graham Net Net. But after waiting for > 6 years, I sold it at some loss to buy another Graham Net Net. It was a case of another better Graham Net Net. Better meant higher margin of safety and what I judged to be a shorter turn around period.
If you want to know more about Eksons, I have a blog post at Is Eksons still a value trap? (May 2021)
If the only way for a company to return more than risk free rate is for market to rerate it. I don't think it's a good investment.
I don't think even Buffett thinks it's a good investment, unless you know a sure-fire catalyst, or there is a sure-fire way to unlock value (say becoming an activist investor).
Might still be a good punt though.
We all make money from 2 sources - dividends and capital gains. Capital gains will have to come from a re-rating of the market. Sure you can get capital gain by having the same multiple with increased earnings. But I find it very hard to find good companies trading at a discount to intrinsic values. Most of the time, underprice companies tend to be those in facing some problems.. that is why the market don't want them. For such cases, capital gain will have to come from improved performance followed by a market re-rating.
We are all mostly retail investors so we have to hunt in our little pond and forget about what the activist and large investing funds do.
Improved performance can also be considered a catalyst. That said, if everyone knows that the setback is temporary and the rebound is bound to happen, then it's also usually priced in.
Personally I like to buy companies in long-term secular growth, where future growth is not fully priced in.
(11-07-2023, 02:07 PM)Wildreamz Wrote: [ -> ]Improved performance can also be considered a catalyst. That said, if everyone knows that the setback is temporary and the rebound is bound to happen, then it's also usually priced in.
Personally I like to buy companies in long-term secular growth, where future growth is not fully priced in.
Whether is it "setback is temporary/rebound is bound to happen" OR "companies in long term secular growth", both are the same at the hip isn't it? Both are expecting that Mr Market underprices what WE believe will happen. Often times, market underprice/overprice setbacks. Often times, market underprice/overprice growth. No surprises.
In general, recovery from setbacks is the exception and one manages the risk via buying at discount to intrinsic value (the popular word in value investing). In general, growing to the sky is the exception and one discounts back their future scenario and ensures they pay for "growth at a reasonable price" (the popular word in growth investing)
Both ways follow the same principles, just that one needs different method and temperament for each.
The two concepts trace to the same roots. But there are some key difference:
Rerating can only happen once. And the timing of it happening (1 years or 10 years etc) will hugely determine your results. And you must sell when it gets rerated, or it will be a drag on your returns (if underlying business does not compound at a high clip).
Buying and owning long-term secular growth companies that can grow owners earnings at a high clip every year regardless of stock price action, allows for long-term compounding to happen, regardless if you get right on the timing.
But you are right. Personal finance, only works out if it suits your temperament.
As a value investor, I found that about 1/3 of my stock portfolios are turnarounds. I wish there were more underpriced long-term secular stocks. The reality is that if it is so obvious that there is good prospects, the price won't be cheap.
The Oracle has advised to buy wonderful companies at fair prices. But he never defined what is a fair price. Sure, he talked about DCF based on the owners earnings as the valuation metric, but did not mention about the discount rate or growth rates. These will have big impact on the valuation.
Damodaran has thing this about your valuation being consistent with your narrative. The sad part is that if you tell a good story your valuation would be high. The issue is not a good or bad story. The challenge is whether your story is realistic. I guess this is where value traps comes in. You get caught in your own positive hype that a bad stock looks like it is going to turnaround.
But you would have thought that a Graham Net Net would be safe. The unknown is how long the company will turnaround and how long the market will rerate it.
The research rpt (dated 2022) below has a list of stocks with net cash% to market cap. Perhaps VB using net strategy with holdings in the high net-cash-to-mkt-cap ratio stocks can share some experience ....
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Fishing in troubled waters
https://mkefactsettd.maybank-ke.com/PDFS/265080.pdf
I have an bad experience with a high cash position. China Stationary is mainland Chinese stationary company listed on Bursa Malaysia. It had tons of cash in its books but when a fire broke out in one of its plants in China, the was a song-and-dance about the investigation etc. All the while you wondered why don't they use the money to rebuild, etc. Anyway to make the long story short, the company eventually went into PN17 and was delisted. Moral of story - be wary of cash holdings from mainland Chinese companies. OK it was years ago, but it makes you wonder about the reliability of the financials.
I would extend that to, beware of the finances of small (e.g., small and microcap) companies from emerging markets, regardless of country of origin. Even microcaps and OTC in America, can't necessarily be trusted. Chinese companies listed in Singapore (aka S-Chips) we barely have any legal recourse if situation turns south; it's the worst case, as the arrangement incentivizes bad behavior.
Once the company exceeds 1bil and get more coverage, it's generally safer, but not fool-proof either (see Wirecard).