Author Notes: I read widely and selective when it comes to the topic of investing. I spend close to every waking moment of every single day learning and updating my knowledge. But I cannot claim credit for the foundation of my ability to invest.
The methods and processes shown in what you are about to read are taught as part of the Intelligent Investors Immersive Program. Feel free to check it out if you feel that this style of investing gels well with you and makes sense for you.
Disclaimer: I am vested in OKP Holdings. All investing comes with risk. DYODD before investing.
The core of all value investing is to pay less for more.
There are many ways to “pay less for more”.
- You can buy something that is $1 now but might be $20 in the future. (Growth stocks)
- You can buy something that is $1 now and probably forever, but will pay you $0.20 every year for owning it, and thus earn more in the future. (Dividend paying stocks)
- You can also buy something at $0.20, when it is in reality $0.40. (Undervalued Companies.)
OKP Holdings (SGX:5CF) belongs to example Number 3. Currently trading at $0.20, we feel the fair valuation for OKP Holdings stands at around $0.40.
This presents investors a 100% upside. If I’m wrong, we net between 10-100%. If I’m right, we net 100% profits. In the meantime, we get to collect whatever dividends the company is willing to give.
That is the kind of investment we are looking for.
Let’s dig into how we arrived at this conclusion to buy the company.
The Strategy: Conservative Net Asset Valuation
I have to begin by explaining the strategy.
Built on the back of Benjamin Graham’s investment concept, the Conservative Net Asset Valuation Strategy specifically seeks to buy companies which are undervalued compared to their Assets.
Naturally, these leads to questions.
What kind of assets should you be looking for?
The answer varies from country to country. But in Singapore, we want to look at two very specific components.
- Lands and Buildings.
- Cash and Cash Equivalents.
If the value of both 1) and 2) supersede ALL liabilities the company currently has, then we can determine the company is basically financially “free”.
They wouldn’t have to make a lot of money or be an insanely profitable business as long as they make enough to live by.
This is because strategically, this is an asset play. We want to own the assets for cheap and own the business for free.
How Do We Know OKP Holdings Is Undervalued?
The annual report tells us everything we need to know. Let’s walk through this together.
Remember that we wanted to buy the assets of the company. Also, remember that we want to buy good assets. Not lousy assets that aren’t worth money.
Put another way, you would rather own $1 million of cash and properties versus $1 million of orange juice which spoils a week from now.
If you total the value in the red boxes and take only half the total value of the yellow boxes, you should arrive at:
|Good Assets (Red Boxes)||$74,275,000 + $49,586,000 = $123,861,000|
|Assets of Lower Quality (Yellow Boxes), apply 50% discount||3,598,000 + 18,575,000 + 1,252,000 + 3,462,000 + 13,493,000 + 20,011,000= $60,391,000|
50% of $60,391,000 = $30,195,500
Total value of the company based purely on its assets at this point would be;
$123,861,000 (red highlighted boxes) + $30,195,500 (half of yellow highlighted boxes) = $154,180,361
Now look up again and find the total liabilities in the orange box highlighted ($63,041,000).
Total Assets – Total Liabilities,
= $154,180,361 – $63,041,000
$91,139,361 is thus the value of the company based solely on its assets right now. Next, we find the total number of shares, under Share Capital.
Now we divide $91,139,361 by 308,430,594 to find the actual value of the company.
- $91,139,361 / 308,430,594 shares = $0.29 is the real value of each share.
- $0.29 is the real value of each share. The current share price is $0.20.
- Net Asset Valuation (total assets – total liabilities) puts the entire company at about $0.40.
This simply means that if I am wrong, and OKP only goes from $0.20 to $0.29, I gain a 45% profit.
If in the long run, something happens which pushes OKP into the public spotlight and its share price rockets to NAV, I gain 100% profits.
Either way, I am supported by A) the company being undervalued versus its assets and B) the company’s profitability even as a business.
Why Is It Cheap Now?
The company most recently got into trouble for the collapse of the PIE viaduct at Upper Changi on 14 Jul last year. One worker was killed while 10 others were injured.
The government has since dropped charges against the Group’s Main Director, Or Toh Wat and instead given him conditional warnings, giving him a discharge without amounting to an acquittal.
This means he can be re-arrested and re-charged for the same offence (versus if he had been acquitted) if new evidence surfaces.
As is obvious, such an event, while unfortunate, does not affect the assets of the company. It affects the business to some degree for sure but not to an immense one as well.
Since assets were not disrupted and since the business was not unduly affected, there is no reason for OKP’s shares to be trading at a 45% discount to its conservative value, and a 100% to its net asset valuation.
All the negative news did was open up a window of opportunity for investors to secure a profit.
To be absolutely certain, as a human being I despise the way things were carried out.
A man died. Multiple workers suffered possibly permanent debilitating injuries.
But as an investor, I cannot allow how I feel about the company to dictate how I should invest. My objective here is to grow my money. Not judge someone for their shaky judgments.
It is also a sad truth that to find companies capable of giving us mind-boggling returns like 100%, we need to dig among the trash and be willing to get our hands dirty.
This is but one such example.
What does Insider Activity Tell Us?
It is well established through many studies that insiders are better informed and earn market-beating returns.
The common-sense wisdom here is that insiders know more about the company than outsiders do and are better able to make more informed decisions, thus gaining an advantage. To be clear, we are only looking for very specific buying signals as investors.
If an insider buys company stock every Feb during bonus time, it does not translate to a credible signal. But if that same insider suddenly bought massive quantities two weeks before an earnings call, that does give us a relevant signal.
I promise it will be worth your time and save you a load of investing pains.
As to insider activity…well…
There has been no activity on insider trading since 2011.
Any material information that mattered from an insider trade 7 years ago is unlikely to matter now. Further, we analysed asset information from 2018. Our thesis is not based on information from 2012.
Let’s move on.
Should You Be Concerned With The Court Case?
Let us recap the facts.
- The company’s business is doing materially ok. OKP despite the accident has an outstanding book order worth $282.6 million. To put that into perspective, they have about two more years of earnings combined. These book orders give us a good amount of predictability with regards to the company’s business. In other words, they’re doing just fine.
- Additionally, construction and engineering businesses recognise earnings rather lumpily. As developers, they first have to use their own resources to front the cost of renovations and then they get paid by project milestones. It’s the same if you renovate your house, just at a larger scale. This means when the earnings do come in, it could create a catalyst event for the share price to shoot up.
- Let’s exercise some further thoughts here. The company has outstanding book orders worth $282.6 million. The company’s total value on the market is only $61 million. So the market is basically telling you that the company is going to EARN $282.6 million but is only worth….$61 million? Unless you’re saying OKP is losing more than $282.6 million to make $282.6 million, this is utterly senseless and inconceivable.
- Let’s not forget that we are buying the company’s assets here. We are fine if the company closes down and liquidates. We actually get more money out of it that way. What we want to watch for is if the company starts to struggle and if its assets start being sold off to fund dumb ideas or money-losing ventures. At that point, it would be better to cut losses and move on. Given the company’s outstanding book order, that is unlikely to happen.
There’s not much to worry about.
There’s very little downside since the share price is supported by the assets surpassing it in value, and the upside is quite large, so I’m satisfied.
When Will I Sell?
Unlike Warren Buffett, I don’t have billions to manage. My investment objective is to quickly multiply my money and to not be ensnared in a value trap -> a company that looks like a good business to invest in but does nothing for years and years.
If time is money, leaving your money stuck in an investment for years while doing nothing with it is not a good idea.
Further, the evidence suggests that the average amount of time needed for a company to correct its undervaluation is between 1.5 to 2.5 years. This is supported by empirical evidence. Not theory.
Thus, my holding period is 3 years. My sell conditions are thus,
- To take profit
- To cut loss if somehow the business assets deteriorate
- To sell if nothing happens after three years.
I hope this read has been instructive for you.
Recommended readings for predictive value of insider trading:
- Insider Trading: A Review of Theory and Empirical Work by Ako Doffou
- Some Insiders Are Indeed Smart Investors, by Daniel Giamouridis, Manolis Liodakis, Andrew Moniz
- Decoding Inside Information by Lauren Cohen, Christopher Malloy and Lukasz Pomorski
Recommended readings to understand the empirical evidence behind undervalued stocks taking 1.5 to 2.5 years to revert to true value.
- Does the Stock Market Overreact? By De Bondt and Thaler.