Schacht Value seeks out investments where a disparity between value and price exists.
Buying securities when this disparity is significant creates a dual benefit: significant
appreciation potential and a “margin of safety” against adverse developments. These
undervalued situations are not always plentiful or easy to identify.
Successful investing depends on finding opportunities that meet our value criteria.
This requires patience. It is also highly dependent on where one looks. Here are some
of the categories that regularly provide interesting opportunities:
Hidden Assets and Values
Many companies fail to attract the attention of Wall Street analysts or are simply
misunderstood. Because of this, value is often hidden in plain sight. Complicated
conglomerates do not fit into a clear industry category. Wall Street loves companies
that are easily defined. Those that are not often get ignored.
Small firms have a similar problem. Because of their size, some companies do not
generate enough interest from investors. Many simply fall through the cracks and go
unnoticed. Whatever the reason, this benign neglect can lead to opportunity.
Hidden values and assets come in many forms. An example may be a company with real
estate holdings that were acquired years ago at minimal cost. The company’s balance
sheet lists the asset at the carrying value regardless of what it may be worth today.
Another more common example is a gem of a company that no one has ever heard of. These
represent a favorite area of investing for us and our portfolio reflects this.
Discount to Private Market Value (PMV)
Private market value (PMV) is the value a knowledgeable businessperson would pay to
purchase a company or group of similar assets. Companies often consider the private
market value of targets when evaluating a possible takeover. Schacht Value places
particular emphasis on an analysis of the company’s normalized free cash flow, which is
generally the most important consideration for a financial buyer. We also consider other
recent acquisitions and the particulars of such acquisitions including the availability
of financing, the type of buyer, and, of course, the acquisition’s value.
Spin-offs, liquidations, reorganizations, and broken acquisitions are special
situations that many investors ignore. This lack of interest is completely unrelated
to the company’s intrinsic value. Furthermore, most investment and research firms do
not focus on these situations either. This creates greater inefficiencies. We analyze
numerous special situations and invest in those where the discounts are most compelling.
Low Price-to-Earnings (P/E) Ratios
When looking for cheap stocks, it is helpful to identify companies that have a low price
relative to normalized earnings or cash flow. When a company is selling for a P/E ratio of
10, an investor is buying $1 of annual, per-share earnings for every $10 in share price.
A company with a P/E of 10 has an earnings yield of 10%, while one with a P/E of 5 has an
earnings yield of 20%. Price to earnings ratios expand and contract for a variety of reasons
and must be viewed within that context. In any case, the goal is the same: to buy a stream
of future earnings at a bargain price.
Discount to Adjusted Book Value (B/V)
Securities that sell for less than the adjusted book value (net worth) on their balance
sheet warrant further evaluation. This is often an indication that investors are paying
very little for the assets of a company. Book value per share is calculated by subtracting
total liabilities from total assets and dividing by the number of shares outstanding. Book
value is often adjusted to add a measure of conservatism by excluding intangible assets and
discounting assets like inventory.
Discounts to Net-Net Working Capital
The minimum liquidation value of a corporation, in most cases, is its net-net working
capital. This net-net value is determined by subtracting total liabilities from adjusted
current assets. If a stock sells for less than this value, it is referred to as a “net-net”.
This usually constitutes an attractive price that warrants further research. While it is
less frequent today, from time to time the market will price companies below this level.
A “net-net” investor is trying to buy a company's fixed assets at no cost, and pay little or
nothing for the business as a going concern. This is even more conservative than the more
common discount to B/V situation above.
The term “fallen angel” refers to a company that once was a darling on Wall Street, which
has disappointed investors enough that its stock price has declined to irrationally low levels.
If the company's balance sheet is strong enough to withstand a difficult period and the long-term
fundamentals of the business are sound, shares of a fallen angel can generate exceptional returns.
“Orphans” are companies that have lost popularity after an initial public offering (IPO).
These companies typically have not lived up to the hype surrounding their IPO. The stock price
has fallen and investors have moved on. The lack of interest and the correspondingly low prices
allow value-oriented investors to find bargains among the orphans.
The above list is not exhaustive. A security need not fall into one of these categories to
be included in our portfolio. These are simply indicators that point us in the right direction.
The safer something seems, the more likely it is to be fully priced.
- James Grant