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Discounts.
Who doesn’t love them?
Especially when it’s real. This holds for investors as well: We always want to buy a stock at a discount to the fair valuation.
The challenge, of course, is determining what a fair valuation truly is.
We may think it’s a specific price, but we could be wrong.
Or the market could move against us, meaning we could have got it even cheaper.
But there is one instance where we can determine whether there is a discount, and that’s when it comes to holding companies that trade on the JSE.
Obviously, their main business is holding other companies, and if those companies are listed, it becomes very easy to determine a discount.
Let’s start by using PSG as an example.
The group owns a number of listed stocks and provides a live sum of the parts (SOTP) on its website, so we know what the ‘value’ of the PSG share is.
But, one thing you’ll notice with holding companies is that, in most cases, they trade at a discount to their holdings.
This is to be expected for a few reasons.
Firstly, the holding company incurs costs, which need to be deducted from the SOTP.
There may also be a capital gains tax (CGT) payment due.
Sure, PSG, for instance, could just unbundle its listed holdings to shareholders with no tax issues for the group, but if an asset has to be sold first (most likely if it is not listed), then there would be CGT to pay and this is then also included in the discount.We also have to watch out for director valuations of unlisted assets.
Truthfully, they’re hard to value, as is any company.
And so, what we really need is a detailed explanation of how they arrive at the valuation.
Brait serves as a good example of a company that is fairly open about how it values its various assets.
This means shareholders are left to decide whether they agree with the methodology or not.
We can also look to other similar companies listed on a stock exchange (locally or globally) to get an idea of whether Brait’s valuation is fair or not.What would bother me very much is if directors kept changing the methodology of their valuation.
Brait recently did make some changes but backed these changes up with reasons.
Also, importantly, as a rule they don’t regularly change their methodology.
What we also sometimes see is that one asset dominates the valuation, as is currently the case with Zeder, which focuses on agribusiness.
Zeder’s main asset is a holding in Pioneer Foods and, frankly, the market is pretty much ignoring its other assets.
This is partly due to the fact that Pioneer is Zeder’s only listed asset and so offers a clear price point.
But another reason is that Zeder’s other assets are relatively small compared to the total value of Zeder.
Let’s consider African Rainbow Capital, whose main asset is Rain – an unlisted start-up.
This makes it very difficult to value. Here investors need to not only simply agree with the valuation methodology being used, but also with the prospects of a start-up.
African Rainbow Capital also has a fairly hefty fee structure that definitely accounts for a portion of the discount as not all profits will flow to shareholders.
The key lesson here is that you need to understand the valuation methodology a holding company is using and make sure you are happy with it. Also ensure that you are always buying at a discount which, ideally, should be at least 15% of the value of the underlying assets.
And finally, be careful.
Just because there is a discount to the assets held doesn’t mean you’re guaranteed a profit.
Valuations could be stretched, or profits could fall.
Or there could simply be a good old-fashioned market sell-off, which will result in falling prices.
This article originally appeared in the 20 June edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.
