The Reid Green & Co investment approach is based on finding companies whose securities are trading at distressed prices, mainly due to a company in temporary distress, distressed market or industry conditions, unpopularity, arcane or overlooked situations or neglect due to institutional constraints. The cornerstone our approach is to find securities in companies that can be purchases at prices below the intrinsic value of the business, which is usually determined by Liquidation value, tangible book value, or earning power, in other words you must only invest in a company when it available at a price substantially below what a rational private buyer would pay for the whole company.
Many brokerages, banks and even asset managers spend a great deal of their time, following economic data, quarterly earnings reports and general daily and weekly fluctuations in stock and commodity prices, all of which is irrelevant to finding and profiting undervalued companies. Typically when these institutions post brokerage reports on companies although they can be quite lengthy and appear to be in-depth, however their analysis of companies can be quite superficial and irrelevant in the context of whether a company is undervalued or not.
Markets to Operate In
Although undervalued companies can be found in a variety of places, there are a number of key markets that Reid Green & Co think are fertile areas to look for profitable investments.
- Depressed General Market conditions and periods or market dislocations
- Distressed industries
- Markets where the competition is generally less informed (e.g. aim market)
- Markets that get less attention from participants. (small cap stocks)
- Sectors that are unpopular
Good Candidates for Potential Undervalued Companies
- Companies that are self-liquidating (when they can be bought at prices below the estimated liquidation proceeds)
- Companies that are trading at their 52-week low, low price to book value and low price to earnings/cash flow ratios
- Companies that are recapitalizing through share buybacks, special dividends, stock and bond issues
- Companies with good earning records that have posted a large loss
- Companies Recently re-emerged from bankruptcy
- Companies going through large operational and debt restructuring
- Companies in the process of litigations where the final result is unknown
e.g Deutsche bank is currently trading at €22billion while its tangible book value is €67billion, which is only 32% of its book value, due to uncertainly around its going litigation for events that took place in 2008 and the fact that it posted a 7billion loss which was only a accounting loss as the bank actually generated €17billion in cash flow.
Mandate for Long Term equity selection
In terms of the coverage Reid Green & Co can provide for a value investor, we typically focus on companies Listed in the UK and US. We like the UK as an investment playground, because while the FTSE 350 gets most of the attention, it only accounts for 15% of the 2200 or so UK listed companies. This leaves 85% of a well developed and regulated market, relatively overlooked.
The US gets our attention for the opposite reason; in the US there are over 18,000 listed companies. The share number of listed companies means that if only 1% of the market present a solid opportunity at any one time, this equates to 180 investment opportunities. Far more than one needs, could manage or even find! And of course the US is a better hunting ground special situations such as changes in control, spin-offs, bankruptcy emergence and intervention from activists.
We generally won’t dismiss a company no matter how large or small, but for the most part we do focus on companies with market values ranging from £10million - £5billion.
In order for us to document and distribute research on a company, we have to think it’s priced at a meaningful discount to what it is worth, preferably 50% or more.
We focus on reality, future value and the key variables
To Reid Green & Co Value investing doesn’t mean “buying stocks with a low PE, low price to book or high dividend yield” which is how the mainstream investment community may categorise it.
Instead we try to understand the economic reality behind the reported numbers and the consequences on future value, while comparing those to today’s prices.
For example if we found a company that was generating 50% + on capital and growing 30% - 40% like the computer company Dell Inc apparently did in the 90s, we would happily pay 20 times earnings for such a company. Additionally we would be interested in a company which traded for a high multiple of it’s book value, if the accounting earnings translated into cash flow, while requiring little or nothing in the way of tangible assets.
Also we don’t try to know everything there is to know about a company, for us to get comfortable with an idea. We only try to get a full and complete understanding of the key variables, which will cause an investment to be profitable.
Hence why we find the following stocks attractive;
- Avation Plc: trading around it’s cash per share, while the underlying business is growing rapidly. The company funds its growth through bond issues to acquire new aircrafts which it then leases to airlines. Because the growth is funded by debt, there is no new equity being issued causing the shareholders to be diluted. Therefore as the company expands, wealth accrues to the share holders.
- Citigroup: a well capitalised bank that appears to be generating a 9% return on equity, but after adjusting for its deferred tax assets, is actually generating 11% on its tangible equity. Meanwhile the bank trades at a discount to its equity and its tangible equity, meaning an investor today is earning a higher return from the stock than the underlying business earns. The deferred tax assets are being consumed rapidly as the company generates cash, and the management are using the tax savings to aggressively buyback its own shares, while they are undervalued.
- Glencore Plc: currently has £41billion in net assets while it trades in the market for £19billion, which means they are trading for around 50% below what a private buyer might pay for the whole company. Over the next two years Glencore Plc are focusing their attention on carrying out a restructuring by reducing their net debt from $25billion down to around $17billion, they are divesting non-core assets and low return businesses and working to cut costs where they can.