For my purposes, I think investing in individual stocks (at the right prices) provides the best reward/risk distribution, i.e. I can achieve meaningful returns while taking modest risk. So, when I use the term asset, I’m generally thinking about stocks.
Most companies I consider investing in fall into a bucket I think of as “not good” quantitatively. That means, I’m not confident—given the company’s past financial performance—that its fair value will increase over time. That doesn’t mean I can’t invest in the company, it just means I can only invest at the right price (at less than current fair value).
For a non-stock example of a “not good” asset, let’s think about a house.
Let’s say you are considering buying a house. An identical house, next door just sold for $500,000. And, you can buy the twin for the same price, so $500,000 is the Market Value. But, how much is the house really worth? What is its Fair Value?
You could try to value the house by how much income it could generate (e.g. if you rented it). If you think you could rent it for $2000/month, $24,000/year, then buying at $500,000 you’ve paid about 21 years of rent to buy the home, or a Price/Rent of 20.8 years. But, what if the identical house that just sold starts looking for renters and only asking $1500/month, then $1000/month. Now, if you need to sell your house, and a potential buyer says I’ll pay what you paid, 20.8 years of rent, your house is now only worth 20.8 years Xs $12,000 annual rent = $249,600. So, in my opinion, the house is a “not good” asset, because there’s nothing so special about it that we can safely assume its fair value will increase, especially amid competition.
For “not good” assets to be buyable then, I need to be able to buy them for less than liquidation or scrap value. So, if we think of a house’s value as the aggregation of its components: the wood, the pipes, the wiring, we can quickly conclude that fair value for most homes is only a few thousand dollars. For example, if the components are worth $10,000 and I can buy the house for $5,000, then I can double my money (not accounting for time and effort) simply by scraping the house. The neighbors lowering the rent doesn’t impact scrap value. But, if I’ve paid $500,000 for the house when its fair value is only $10,000, I could be in a lot of trouble.
Buying a house for $5,000 probably isn’t an opportunity you’ll encounter. But, you can find stocks that trade for a fraction of fair value.
For example, Takahashi Curtain Wall Corp, a Japanese company that trades on the Tokyo Stock Exchange under the symbol 1994. The company is engaged in the construction and building industry, but that’s not why it’s interesting. It’s interesting because—by my calculation—the company’s liquidation value is ~1246 yen/share. Yet, the stock closed Friday at 511 yen/share. In fact, the company has traded below liquidation for a long time. Over the past 5 years, it has traded at an average of 0.7X liquidation value, so I use that as my estimate of fair value. 0.7X liquidation value is 872 yen/share. So, if you bought at Friday’s close of 511, you bought at 59% of scrap value. There’s no guarantee you’ll make money buying at such a discount, but the discount reduces the likelihood of taking a meaningful loss. And, if the stock simply trades at 0.7X liquidation value again, that would mean a gain of ~70%. So, even though Takahashi Curtain Wall Corp is “not good” quantitatively (i.e. nothing about its past financial performance inspires great confidence that liquidation value will grow) the current discount to fair value at which it can be bought, seems likely to make it a good investment, if it is a small part of a diversified portfolio. Thus, I own shares of Takahashi Curtain Wall Corp.
The information in this post has not been audited and accuracy is not guaranteed. The post is for informational purposes only and is not investment advice. Consult a financial professional before making investment decisions. The author’s opinions and positions may change subsequently, without notice.