Undervalued Asset Companies, The Peter Lynch Playbook [4/7]

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Disclaimer: The author is vested in HKC and Emperor Watch. This article is not an incitement to invest. Please conduct your own due dilligence.

This would be the fourth article of our 7-part Peter Lynch Investing Playbook series. 

If you’ve missed the first part, fret not, as you can read it here: Part 1 of The Peter Lynch Investing Playbook. Don’t worry, this article would not be going anywhere so you can come back to it anytime! 

The Peter Lynch Investing Playbook is essentially a guide inspired by the book, One Up on Wall Street, where the legendary investor, Peter Lynch, revealed how his ‘amateur’ approach in managing Fidelity’s multibillion-dollar Magellan Fund led him to become one of America’s number one money managers, and, one of the most successful investors of all time with an average annualized returns of 29% a year.

Peter Lynch’s thesis is simple -> It is not necessary to be a math or finance professional to invest and benefit from the stock market.

So-called amateur Investors do not require mastery of arcane financial principles.

They simply need to hone a sense of keen observation and build a wealth of common sense to capitalise on how to recognise good companies ten steps ahead of the so-called professionals -> who never leave their cubicles.

There are different types of stocks and Peter Lynch classifies them into 6 general categories. He’s found that these 6 categories cover all of the useful distinctions that any investor has to make. 

Today, we would be going in-depth into one of the six different categories pointed out by Lynch – The Asset Plays

What Are ‘Asset Plays’?

Asset Plays are stocks that are believed by investors to be undervalued because the current price does not reflect the current value of the company’s assets displayed on its balance sheet.

The rationale for purchasing the stock is that the company’s assets are being offered to the market relatively cheaply, making it attractive to investors.

It would be sort of like buying a house for $0.40 on the $1.

Investors who utilize this strategy believe that the market overreacts, resulting in stock price movements that do not correspond with a company’s long-term fundamentals, giving an opportunity to profit when the price is deflated.

In fact, here at Dr Wealth, we employ our Conservative Net Asset Valuation (CNAV) method to identify to evaluate and select deeply undervalued Asset Plays.

We provide “Skin in the Game” case studies of our winning stocks that were hand-picked using our proprietary CNAV screener, substantiating them with past transaction statements. 

We would thus be picking stocks utilizing the following criteria to select our Top 3 Asset Plays: 

  1. Company’s CNAV2 value is at a discount from Market Price.
  2. Company’s POF score is 2 and above.
  3. Passes our 3 Point Qualitative Analysis

To elaborate a little further on the above criteria: 

  1. Company’s CNAV2 value is at a discount from Market Price

This is the formula we use to calculate a stock’s Conservative Net Asset Value: 

  • Good Assets are defined as Cash, Cash Equivalents, Lands and Buildings.
  • IGA are Receivables, Investments, Inventories, Intangible Assets.

All of which can be found in the Balance Sheet of the company’s financial statements. 

We would then take the CNAV2 value, divided by total shares outstanding to find the CNAV2 per-share value

Thus, if the CNAV2 per-share value is HIGHER than that of the current price per share, it is deemed to be on a discount. 

  1. Company’s POF score is 2 and above.

To make our selection more stringent, we turn to Dr Joseph Piotroski’s F-score to find fundamentally strong low price-to-book stocks that are worth investing in. 

As we have already added conservativeness, ​​​​​we do not need to adopt the full 9-point F-score. A proxy 3-point system known as POF score would be used instead. 

It stands for Profitability, Operating Efficiency and Financial Position.

  • For Profitability: Price to Earnings Ratio = 0 < PE < 15
  • For Operating Efficiency: 2 out of 3 years with positive cash flow from operation 
  • For Financial Position: Debt to Equity Ratio < 100%

The stocks selected has to have a POF score of 2 and above.

To learn more about the POF score and how we use it in our investment strategies, click here

  1. Passes our 3 point Qualitative Analysis. 
  • Corporate Actions:
    • Since an Annual Report is merely a “snapshot” of the company’s financials, things can change rapidly. Thus, we have to look out for corporate actions that the company will have to disclose under the Singapore Exchange. For example, share buybacks, share splits, disposal of assets, etc.
  • Dominant Assets:
    • When you look at the company’s financial statements, you must assess it for the assets you are purchasing. We also want to watch out for assets that might be depreciating very quickly such as food produce and or inventories that might be outdated by industry standards. 
  • Trustworthiness:
    • Did the company financially engineer its books? Is management open and honest? Can they be relied upon to not “cook” their books?

An easy way to bypass such subjective questions is to look at whether management owns the majority of the shares in the company.

Adopted from The Swedish Investor

Today, we would be looking at the Hong Kong Stock Exchange market due to the recent correction caused by the protests. This resulted in many counters being ‘On-Sale’ even though its fundamentals have not faced any drastic changes. 

Why these 3 stocks? 

To facilitate your reading, we have structured the content into clear and concise points to sum up what you have to know: 

  1. What does the company do? 
  2. What are their assets? 
  3. Why is the stock undervalued? 

While there isn’t a hard and fast exit strategy, at Dr Wealth we would either sell at the 3 year holding period, when the Financial Fundamentals change or when a key qualitative point has been changed (i.e. change of CEO/founder steps down). 

  • 3-year holding period: We wouldn’t want to be stuck in a value-trap for years and would rather re-allocate our capital to more promising counters we identified. 
  • Financial Fundamentals change: This is mainly signalled by a change in the POF score of a company. If the score drops below its prior number, it should be a good reason to review one’s decision.
  • Key qualitative point has been changed: Imagine Amazon without Jeff Bezos or Facebook without Mark Zuckerberg. There would be huge distress should the company fail to find a suitable replacement for the leadership. However, it is not all doom and gloom, evident in Tim Cook’s helming of Apple after Steve Jobs. 

#1Emperor Watch & Jewellery (HKSE:0887)

Market Cap.$1.173B
Market Price$0.173HKD
CNAV2 Value per share$0.386HKD
Net Asset Value per share$0.659HKD
POF score3
Potential Profit281%

What does the Company do?  

Emperor Watch & Jewellery is a retailer of European-made internationally renowned watches such as Patek Philippe, Rolex and Tudor. This is coupled with the sales of self-designed fine jewellery under its own brand, ‘Emperor Jewellery’. 

The company has a history of over 75 years, establishing over 90 stores across Hong Kong, Macau, mainland China, Singapore and Malaysia, as well as an online shopping platform, and now has over 1,100 staff. 

What Are Their Assets? 

As seen in the infographic above, Inventories and Properties make up the bulk of their assets. There is a whopping HK$3.09 billion worth of luxury watches and Jewellery.

My hypothesis was that it wouldn’t be that bad because luxury watches and jewellery retain value pretty well as long as they are not worn and still in good condition.

We went ahead to discount the current inventory of watches and jewellery at 50%. We should account for a large margin of safety when calculating the valuation of Emperor Watch & Jewellery.

Why is the Stock Undervalued?

The Company’s core strategy focuses on maintaining its position as the leading watch and jewellery retailing group in Greater China, coupled with an eye on expansion beyond the region.

As most of their customers are mainlanders, boutique stores that peddled luxury goods such as watches and jewellery enjoyed the patronage of this swell of new customers as a result.

However, most of this all came to a halt when President Xi Jing Ping decided to rein in on the corruption

This discouraged ostentatious displays of wealth in public. Sales of luxury goods to Chinese consumers slowed for a time and as earnings dropped, so did share prices.

Coupled with the recent 10 straight weeks of anti-government protests in Hong Kong, stock prices in the HK Exchange have inevitably taken a massive beating. This is without even mentioning the massive backdrop created by the Trump-China trade war affecting prices as well!

More than $600 billion of stock market value has been erased since early July thanks to the riots and protests. 

The culmination of all these events have thus done something favourable for us; create opportunities for us to businesses at fantastic bargain prices.

#2Wheelock Co. & Ltd. (HKSE:0020)

Market Cap.$97.101B
Market Price$47.4HKD
CNAV2 Value per share$68.357HKD
Net Asset Value per share$105.846HKD
POF score3
Potential Profit121%

What does the company do?  

Wheelock & Co. is principally engaged in property development in Hong Kong, and in property investment and development in Singapore. 

Their major subsidiaries include Wharf (Holdings) Limited (HKSE: 00004), Wharf REIC Limited (HKSE: 01997), Wheelock Properties Limited and Wheelock Properties (Singapore) Limited.

  • Wharf (Holdings) (HKSE: 00004) 65%-owned by Wheelock, is a listed company principally engaged in property development and investment in Mainland China, other Hong Kong properties as well as non-property business in Hong Kong and the Mainland.
  • Wharf REIC (HKSE: 01997) 63%-owned by Wheelock, is a listed company which owns and operates premium, quality investment properties in prime locations in Hong Kong, as well as certain Mainland China property interest.
  • Wheelock Properties 100%-owned by Wheelock, spearheads the Group’s property development business in Hong Kong.
  • Wheelock Properties (Singapore) 98.9%-owned by Wheelock, is the Group’s property arm in Singapore, where it focuses on luxury residences and retail leasing.

What are their Assets? 

As seen in the infographic above, Properties make up the bulk of their assets. This should be rightfully so as they are engaged in the property development business. 

Due to the sheer amount of properties available in the company, we would only touch on the assets of Wheelock Properties here. 

Kindly refer to the company’s website should you like to find out more about its other major subsidiaries asset breakdown. 

Why is the stock undervalued ?

  1. This was mainly caused by the China-Us trade tensions which were exacerbated in April due to President Donald Trump’s legendary tweet, stocks listed in the HKSE took one of the biggest hits and remained under pressure.
  2. Bullish sentiment on Chinese/Hong Kong stocks quickly faded as Trump unexpectedly announced he would more than double the levies on US$200 billion worth of Chinese imports and threatened to include more items that are not covered by tariffs. This thus caused Wheelock’s stock to correct due to macro pressures. 
  3. The next correction was due to the anti-extradition bill protests in Hong Kong. This was the second macro headwind that caused the Hong Kong Stock market to plunge, taking Wheelock’s share price with it. 

#3HKC (holdings) Properties (HKSE:0190)

Market Cap.$2.48B
Market Price$4.69HKD
CNAV2 Value per share$15.067HKD
Net Asset Value per share$24.966HKD
POF score3
Potential Profit420%

What does the company do?  

The Group is a Hong Kong-based property developer focusing on investing and developing property projects in Mainland China and aims to develop high-quality products to create sustainable value for its shareholders.

The Group has a diversified property portfolio model with investments in both residential projects for sale and commercial projects mainly for rental income.

The group is organized into 3 main operating segments:

  1. Commercial Projects – This segment is in the business of the development of commercial properties mainly for rental income.
  2. Residential Projects – This segment is in the business of the development of Residential properties mainly for sale.
  3. Renewable Energy Projects– This segment is in the business of the private development of wind farms.

Over the long term, the Group seeks to maintain a balance between residential development for sale and commercial investment properties for lease in order to create a sustainable model with growth potential.

Residential properties for sale generate fast turnover, which should enhance return on equity. Investment properties for lease, on the other hand, create steady recurring income and cash flow as well as long term capital appreciation and are relatively immune from the periodic restrictions on residential properties.

The Group has also made an investment in the renewable energy sector and believes shareholders may benefit from China’s need to develop non-polluting sources of energy. 

What are their Assets? 

As seen in the infographic above, similar to Wheelock & Co, Properties make up the bulk of their assets. This should be rightfully so once again as they are engaged in the property development business. 

The assets are mostly located around the more developed, coastal regions of China – where population density and income levels are much higher. 

Why is the stock undervalued?

This could largely be attributed to the slowdown of the Chinese property sector in 2018. China’s massive property market is expected to cool further in 2019, with smaller price rises and falling home sales adding to pressure on the world’s second-largest economy, a Reuters poll showed.

As a result, residential sales volume began declining in the second half of 2018, with declines of 1% year on year in September and October and 4% in November. It increased by 2.5% in December, but poor Chinese New Year’s data suggest that the decline will continue into 2019.

Moreover, the price rise growth for new residential properties has decelerated for the third straight month. In January, residential prices for 70 major cities increased by only 0.61% compared to December, the slowest pace in nine months.

Conclusion 

Ultimately, penny stocks are often viewed as easy-to-assess investment choices because of their low capital requirement.

However, as with everything the saying goes, “nothing worth having comes easy”.

Penny stocks are known to be risky. If you are the type who has a higher risk tolerance, then penny stocks might be suitable for you.

But for those who are in a position where risk is not an option, it is perhaps better to stay away. Penny stocks have a higher level of volatility, which entails a higher set of precautions.

To find out about them means having to do your own meticulous research.

Alternatively, if you want to cut short the learning curve, you can join our Factor-based investing where we share how we uncover gems in penny stocks.

Do whatever you feel fits you best.

At the end of the day, as investors, you should always proceed with caution in whatever you are investing in—whether it is penny stocks or not. Keep both the potential rewards and risks in mind.

Finally, always keep your expectations realistic.

Investing often takes months and years for your gains to materialise. If you expect to earn in just a week, then you are bound to be disappointed.

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