I came across this question recently while researching an unlisted stock. Readers are probably aware that I'm fascinated, and intrigued by unlisted stocks. The unlisted market place is a lot less efficient, and there are some good companies selling at cheap prices, but that's not what ultimately attracts me to the market. Pure curiosity is what attracts me to unlisted stocks. For some reason the idea of Googling for hours trying to find little bits of relevant information is a challenge I enjoy. At some levels investing in an unlisted company is like making a small private equity investment. The investor needs to be willing to be patient and lock up capital potentially for years. Buffett's comments about buying companies that investors would be willing to hold if the market was closed for 10 years is very relevant with some unlisted stocks. Some of these stocks only trade a few times a year forcing an investor rely on the long term approach. But with that long term approach can come some rewards, there are unlisted companies selling with P/E's of 6x and ROE's of 20% or more. Other companies are piles of high quality assets selling for next to nothing.
I purchased shares of a company which will remain unnamed, because of a document I signed mentioned further down. I have a $7.80 position, enough for a few shares, which legally give me the right to financials as a shareholder. I contacted the CFO and requested a copy of the annual report, which they denied. Instead I was sent a proxy statement for the past two years and a terse email stating that since this company was now "private" they didn't need to send annual reports to shareholders. The CFO was incorrect in stating this, but it isn't uncommon the management at some unlisted companies to be standoff-ish to shareholders, and treat a company as private even when it is not.
After going back and forth with the CFO he agreed to answer a few questions about the balance sheet only if I signed an NDA. He refused to send the annual report, but did answer some things I had asked for. I want to mention, I hate NDA's, and hate management that refuses to be transparent, but I also want to find good investments, sometimes compromise is necessary. This brings me to the question in the title of this post, what does an investor really need to know?
Here's how I approached this challenge. The company is a services business, and a note in the proxy detailing related transactions mentioned that the company leases facilities from the CEO and Chairman. Based on this statement I could presume that they don't own property, and they don't have any inventory, so I am fairly certain that assets consist of cash, receivables, and marketable securities. Assets, no matter how great, or high quality don't matter if they're dwarfed by liabilities. The most pertinent question regarding the balance sheet is what are the liabilities? I asked this to the CFO; the company has payables, and the lease expense mentioned in the proxy, but they have no debt. Knowing that the assets are un-encumbered the next relevant piece of information was "what is book value?" The CFO sent me the book value figure, which is above the current market cap.
Knowing that the balance sheet is strong, and stable my attention turned to the income statement. The company is extremely protective of the income statement. I was told that competitors have purchased shares and sued for information which they used to figure out the company's pricing model. They then used this information against the company. Given this history I can understand the company's anxiety towards giving out an income statement. With this particular company I have a slight advantage, I have consulted in their industry, and am very familiar with the pricing formulas and pricing data. I don't know specifics to this company, but I know the industry is very commoditized, and their margins are in a tight band with other industry players I'm familiar with.
Of course knowing industry pricing and standard profit margins isn't of much use if the company's revenue can't be determined. I was able to triangulate the company's revenue from a strange note found in the proxy. The CEO of this company is not technically an employee, they are a contractor, and their company gets paid based on certain revenue targets per month. The company disclosed how much was paid to the related party, because the CEO is the son-in-law of the Chairman, and from that value I was able to figure out the company's revenue for the past year. Knowing revenue and estimated profit margins I have a good idea of their profitability.
Probably the most vital financial statement is the cash flow statement. If a company has a great balance sheet, but they are eating cash the balance sheet will eventually disappear. In this particular case it's impossible to generate a cash flow statement estimate based on the few figures I could find, but I had something else that was even better than a cash flow statement, dividend history. The company has been paying sizable and increasing dividends for the past three years. The stock yields north of 10% at current prices. Based on revenue the company's dividend margin is 2%. I know the company doesn't pay out all of their earnings as dividends because book value increased at a 12% clip over the past decade. Some of the company's earnings are being re-invested, and others are being paid out in cash.
After piecing together all this information it became very easy to put together an investment thesis. Would I consider buying shares in a company that:
- Is selling for less than book value, is debt free and has a high quality balance sheet.
- Has had increasing revenue and profits over the past three years.
- Has grown book value at 12%+ annualized over the past decade.
- Pays a solid dividend currently yielding 10%+.
When framing the company as I did above they really look attractive, and the lack of further information might not be much of a problem. What additional information would make this a better thesis? Would knowing an exact P/E, or EV/EBIT make the company more attractive? Would knowing the exact value of the FCF yield matter when they are paying a 10%+ dividend?
The biggest dings against the company are inside ownership, and the related party transactions I'm already aware of.
Benjamin Graham states that you don't need to know a man's exact weight to know that he's fat, in a similar manner I don't think an investor needs to know exact details to know that this particular company is cheap.
I haven't increased my $7.80 position, and I'm not sure that I ever will, but I have thoroughly enjoyed researching this company, and it really made me think long and hard about what information is absolutely necessary to make an investment decision. Of course like all investors I want the security blanket of an annual report, even if there is nothing new to add to my thesis I would like the opportunity to read it.
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