Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
I have a soft spot for old Westerns, the type where it's easy to tell the villains and heroes apart – largely because the bad guys are framed in posters proclaiming they're wanted either dead or alive.
When it comes to stocks, is it possible to want them dead or alive? It might be, provided they have enough assets that can be liquidated at a profit. In such cases, investors stand to make money if a firm goes bankrupt, but can also do very well should it turn around and thrive.
Benjamin Graham, the dean of value investing, liked to invest in situations like this when he managed money in the Great Depression of the 1930s. At the time he pointed out that many large – and profitable – companies could be purchased for much less than the value of their cash holdings. He reasoned that it would be hard to lose money by buying a diversified selection of such firms.
Mr. Graham also argued that a company's excess cash should be sent to shareholders. But even today many firms cling on to their cash reserves when they should be paid out.
For instance, Apple Inc. of Cupertino, Calif., holds over $100-billion (U.S.) in investments that aren't required for its operations. Until recently, it was loath to part with the money and shareholders had to prod the firm into paying a dividend.
Unfortunately, Apple currently trades at a premium to the value of its excess cash. But that wasn't always the case. I bought shares of the company about a decade ago when they could be had for about the amount of money the company held in the bank. Back then, its prospects weren't very good, but that obviously changed in a big way.
It's also an example of why I'm a fan of profitable companies with lots of assets that trade at low prices. If they're managed well, such firms have limited downside risk and they could do very well should their fortunes turn.
I like to use a method Mr. Graham suggested in the 1930s to find very cheap stocks. He started by adding up a firm's current assets and then subtracting all of its liabilities to determine its "net-net" value. This is a conservative estimate of how much a company is worth. Ideally, investors should look to buy stocks at a big discount to this value.
I recently screened for companies on the TSX trading below their net-net value while sticking to those that cost more than $1 (Canadian) per share. According to S&P Capital IQ, the candidates, in order of declining share price, are Goodfellow Inc., Hartco Corp., Hanfeng Evergreen Inc., BENEV Capital Inc., Automodular Corp., Bri-Chem Corp., Migao Corp., Alderon Iron Ore Corp. and Hammond Manufacturing Ltd.
Now, be warned: All of these firms are small and warrant considerable study before purchase.
But one that caught my eye was Goodfellow of Delson, Que., which I've been tracking for some time. It's a wholesaler and distributor of wood and wood-based products with operations primarily in Canada and a small presence in the United States.
Goodfellow is one of the healthier firms on the list because it is actually profitable. However, the last few years haven't been kind to it. Its earnings have tumbled to roughly 31 per cent of what they were in 2010.
Even worse, its near-term prospects aren't great. I'm particularly worried that a big decline in the Canadian housing market could really put a crimp in its already marginal business.
On the other hand, like most net-net stocks, the company has largely been given up for dead by the market. It seems likely to survive, and even a modest revival could result in a healthy bounty for shareholders who are prepared to saddle up for what could be a wild ride.
Norman Rothery