There is a store in the city selling $10 notes for $8.70. You would think that the queue would wrap around the block but this hidden gem seems largely undiscovered……
Whilst this store doesn’t really exist, the principles do and we apply them to our investment thesis.
Several factors should be examined to determine the value of a company, not just share price. At Glennon Capital we focus on gathering information that has not been fully appreciated or understood by the market. Our rigorous and detailed valuation methods allow us to form an opinion on the intrinsic value of a company – which often differs from the market price.
This is due to a variety of factors affecting the market including elements such as sentiment, liquidity, news flow, international capital flows, differences in institutional trading objectives and behavioural biases of other investors. We then carefully monitor the stock for buying opportunities, knowing that if we purchase the stock at less than the intrinsic value then we have built a margin of safety for our shareholders into the purchase.
Our portfolio management process therefore revolves around buying stocks from our watch-list when those valuations become attractive. Patience and discipline are important elements. Panic is liable to lead to mistakes.
Because business fundamentals are subject to change, and constantly do, we continue to monitor those companies for any changes which may affect our valuation. If there is a material change that we believe will affect the share price we take the appropriate steps.
Our goal is to always have a portfolio of stocks that will grow in share price over time.
Discounts are good things
Similarly, investors in a Listed Investment Company (LIC) may be able to purchase the listed vehicle for less than the value of assets it holds.
This is commonly referred to as a discount to NTA.
When a company manages a LIC it purchases assets to form part of a portfolio. LICs have a pre-tax and post-tax NTA figure. Pre-tax is the current NTA as it stands, and Post-tax is calculated assuming that all the LIC’s holdings are liquidated and the appropriate level of tax is paid.
Shareholders buy into the portfolio via an exchange, such as the Australian Securities Exchange (ASX), by paying the current price.
The price is determined by supply and demand. Generally, low supply and high demand increases price. NTA is determined by the aggregated value of the assets. There is no correlation between the two.
The share price may be less than the NTA (a discount) or more than the NTA (a premium).
So why would a LIC trade at a discount to its NTA?
There are many factors which determine a lower share price; poor portfolio performance is the obvious one but it is not the only possibility. Other factors may include the market factoring in fees, a short track record, market sentiment and timing to name a few. However, these factors do not mean that the underlying business won’t increase its share price over time – especially if the portfolio is performing well and there is good communication (and marketing) to existing and potential shareholders.
Essentially you are buying the LIC at a sale price because its assets are worth more than you are paying for them. Take Glennon Small Companies Limited (ASX: GC1) as an example – had you purchased shares on 30 September 2018, you would have paid $1.00 for each share but for that $1.00 you would have received $1.12 (after tax) of assets, plus you would be in line to receive an annual fully franked dividend of 4 cents* per share.
We like buying things at sale prices, especially if we know the product is good quality and will stand the test of time.
*Based on FY18 dividends