Screening for Value using P/B: Filtering out the junk

In my last article, I introduced another classic value metric: Price-to-Tangible-Book, and explained why buying stocks at a discount to this may indicate undervaluation. As usual, I used the Stockopedia screening facility to search for potentially undervalued UK stocks. As many value investors do, I demanded a margin of safety by looking for PTBV < 0.7, with a check on balance sheet strength and also excluded some difficult to analyse sectors, such as banks. I kept similar market cap constraints to the 52-week lows screen. However, in this case, the £600m upper limit is mostly academic; large companies rarely trade at a discount to Tangible Book Value outside of the banking sector.

The resulting stock screen generated 38 results, which is too many to analyse in any detail at this stage. My aim in this article is to narrow down the field to the best 10-20 stocks for further analysis as quickly as possible. One of the keys to using stock screens to generate ideas is being able to rapidly home in on the most promising opportunities.

This endeavour is helped by the fact that this is the second Screening for Value stock screen. The results from this screen contain nine companies that appeared on the 52-week lows screen, and I won’t look at these again. It isn’t unusual to find this duplication since cheap companies are often cheap on a number of metrics.

With the 52-week low screen, we looked for excessive debt, pension deficit or evidence of earnings manipulation as reasons for initial exclusion. These will be less relevant to this screen since these companies may have no earnings, and any debt will be included in the net asset figure. This means that asset quality and cash burn are usually more important aspects to consider for discount to Tangible-Book-Value stocks. These are particularly relevant for the resource stocks that appear on this screen. The tangible assets here are often the net present value of commodity reserves and production or pre-production machinery in challenging locations. These assets are very difficult to value. My general rule is only to consider these stocks further if they are cash flow positive.

Pension deficits can also still be an issue here since the Triennial valuation, which the Pension Trustees use to agree on recovery payments, can be much larger than the accounting figures used to calculate the book value. Accounting rules mean that some pension schemes will be reported as in surplus on an accounting basis, even when the company is required to make significant recovery payments. Unfortunately, there is no foolproof way of identifying issues apart from opening the last annual report and searching for the word “triennial” or the phrase “pension recovery”.

Before I do that, though, I am going to use a nice feature of Stockopedia, which means that when I access a Stockreport from screen results, or from a portfolio that I have created, I get this bar at the top that allows me to easily scroll through the Stockreports for all the companies:

In this case, I am using a portfolio I have created, which contains the screen results minus the stocks I already looked at in previous articles. By looking through the Stockreports and scanning the last few RNSs for each company, I am able to quickly determine if there are insurmountable problems precluding further analysis. Here are the companies (in ascending P/TBV order) that I am excluding and why:

Sound Energy (LON:SOU)

The bulk of the assets of this business is capitalised oil production costs. The company appears to be cash flow negative since the cash balance has gone down since the last accounting date and the company recently had a placing. These assets may be valuable, but I am not able to judge this.

Dolphin Capital Investors (LON:DCI)

This property company appears highly-complex, with development assets in various European countries. The company hold significant cash reserves but doesn’t pay a dividend. Combined with the drawing down of debt facilities, this suggests that all the cash is committed elsewhere. Therefore, I am putting this in the “too hard” pile.

MHP SE (LON:MHPC)

This is a Ukrainian poultry producer. Given the war in Ukraine, I don’t think that we can consider the assets here at face value. A large debt pile means that a small haircut on asset value means that the discount to tangible book value will evaporate. The very brave may want to consider the earnings here, but as an asset play, this is unattractive.

Kore Potash (LON:KP2)

The main assets of this business are pre-production investments into a potash mine in the Democratic Republic of Congo. Again, the value investor is unlikely to be able to accurately determine the current value of these assets.

Aseana Properties (LON:ASPL)

This is a Malaysian property company. The Price-to-Tangible-Book here is only 0.38, so this would be attractive on the surface. However, there is no way that I could have an informed view on the Malaysian property market, or the ability of the management to navigate it successfully. If there was a long history of dividend payments, there might be scope to consider this company. However, in this case, the payout is zero.

Rockhopper Exploration (LON:RKH)

Again, the lack of significant revenue and free cash flow from this oil and gas company means that I exclude it from further analysis.

Ceiba Investments (LON:CBA)

This is another international property company. In this case, specialising in Cuba. Again, I don’t see how a private investor in the UK can assess the true underlying value of the assets. So without dividends to give some measure of the potential returns to investors, I am not going to look into this any further.

Enwell Energy (LON:ENW)

Enwell Energy is another company operating in Ukraine. In this case, in the oil and gas sector. Again, the political risk here is significant and beyond my ability to judge.

Diurnal (LON:DNL)

This is a loss-making pharmaceutical company, where losses are forecast to continue. Although the company currently trades at a discount to its cash balance, the rate of cash burn means that this is likely not to be the case in the future. This is only for investors who have the specialist skills required to analyse the effectiveness and marketability of pharmaceutical remedies.

Abingdon Health (LON:ABDX)

This biotech company is forecast to be very cheap on earnings. However, given that the forecasts have been static for some time, I don’t place much confidence in these forecasts.

Investors should be wary when they see an Analyst Consensus graph like this. In this case, it looks even more unrealistic knowing that this is a covid-testing company that is likely to face reduced demand for its tests going forward. A recent settlement with the DHSC means that they have significant cash balances. However, there is every sign that they intend to reinvest this cash into a highly-uncertain testing marketplace rather than return it to shareholders.

Reabold Resources (LON:RBD)

This is another oil & gas company that is forecast to have small revenues and ongoing losses. It may have great potential, but it isn’t one for the value investor.

Trellus Health (LON:TRLS)

This is a recently-listed biotech company that has more cash than its current market cap. In some circumstances, a negative enterprise value will be attractive to value investors. However, as a recent float this money will undoubtedly be invested in developing and marketing their therapeutic drug. Therefore, investing here requires taking a view on the potential success of this, something I am ill-equipped to do.

Amur Minerals (LON:AMC)

Normally, I would simply exclude Amur minerals as a pre-production miner in Russia. However, the company has sold their mining rights to a Russian company for $35m, above the NAV in the accounts. They also intend to pay a 1.8p per share dividend within 90 days of completion. This compares favourably with a 1.35p quoted ask price. Shareholder approval for the transaction must be a given at this point, but also appears to require Russian government approval. In the current environment, there has to be a material risk that this isn’t given.

First Property (LON:FPO)

This company has a mix of directly owned properties in Eastern Europe, plus equity stakes in other funds. This complexity, combined with a P/TBV that has recently risen slightly above the 0.7 screen cut-off, means I am excluding this.

With an initial look through the Stockreports, I have eliminated a further 14 companies from further analysis. This leaves 15 companies that warrant a more detailed look: Airea (LON:AIEA) N Brown (LON:BWNG) Camellia (LON:CAM) Conygar Investment Co (LON:CIC) Helical (LON:HLCL) Hunting (LON:HTG) IG Design (LON:IGR) Northamber (LON:NAR) Petra Diamonds (LON:PDL) Panther Securities (LON:PNS) SDX Energy (LON:SDX) J Smart & Co (Contractors) (LON:SMJ) Sutton Harbour (LON:SUH) Thinksmart (LON:TSL) Wynnstay Properties (LON:WSP)

I will go through these in more detail in my next article.