Value investing

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6. Undervalued assets - property companies

Traditionally property companies trade at a discount to their underlying net asset value.

In other words, if the whole portfolio is sold and all debts repaid there is enough cash to pay shareholders at a rate per share higher than the current share price.

But:

Not all property company shares that trade on a discount are good investments. The quality of the valuation is important because if a company's assets are valued by the directors themselves it may be a little partial.

Even if the valuation is fair, a property is only worth what someone else will pay for it and in a distressed sale is unlikely to realise its 'true' worth.

Apart from property companies, many industrial companies have high levels of fixed assets, particularly if they are in manufacturing when they will have factories, offices, plant and machinery and so on.

The undervalued assets game is not an easy one for private investors to play, because acquiring reliable information about the value of assets is not easy. An additional frustration is that even if you find an undervalued company and invest in it, the market may obstinately refuse to play the game (i.e. re-rate the shares).

In the example below, the assets of a company actually increase further in value, but the market plays the ultimate trick by widening the discount:

Example

A property company whose share price is 100p, and whose NAV per share is 120p, is priced at a 16.7% discount to its NAV.

The asset value rises by 50% to 180p.
All the value investor asks is that the market maintain its rating and that the share price increases by 50% to 150p.

Alas, if property companies are out of favour, the market's reaction might be to widen the discount of share price to NAV from 16.7% to 30%.
Instead of going up 50%, the share price goes up 26% to 126p, against an asset value of 180p.

In other words, buying into a stock when it is undervalued is no guarantee that the market will revalue the stock and increase the share price the way you would like it to, even when the value of assets appreciates even further.

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