I'm always impressed by the winning research, analysts will go into lengthy discourses about why the cost of toilet paper is going to increase because taxi drivers in London are now using iPhones. The thoroughness and depth of research is impressive. These research reports remind me of a quote by Jean-Marie Eveillard in the book The Value Investors: "After I retired in 2006, I helped teach a value investing course at Columbia University. I had about 12 students, and what struck me was that 11 out of 12 thought qualitative analysis had to involve 25 pages of writing. What I tried to stress to them was that they needed to think hard and then list no more than three to four strengths and weaknesses of the business."
The only compensation I receive for my own investment research is what returns I make as a result. If I were paid to write reports maybe I'd have a different perspective, but as it stands I want to do the least amount of work to achieve acceptable results. My entire investing philosophy can be summed up in the following phrase "purchase real assets cheaply, and earnings cheaper." The beauty with value investing is a simple thesis can be just as effective as a 450 page tome. As long as an investor buys cheaply enough, and has patience to see the idea through they will do well.
Many of my investments fall into three categories, low price to book value stocks, net-nets, or cash boxes, which could also be considered low EV or negative EV stocks. There has been a lot of discussion on negative EV stocks recently as the CFA Institute came out with a research article regarding them. The author's research showed that the average return was 50.4% for all negative EV stocks, and 60.5% for stocks with market caps under $50m.
I would guess some of the return is due to benign neglect on the part of value investors. Investors understand low book value stocks, or net-nets. These are companies selling for less than the sum of their assets, machinery, buildings, real estate etc. A negative EV stock is easy to grasp, it's a giant pile of cash with some semblance of a business attached. While easy to understand, my impression is negative EV stocks are the ones value investors avoid the most. There was a lively discussion at OTC Adventures about this recently, with most commenters disagreeing with me that these types of stocks should be considered.
The main objection to a low or negative enterprise value stock is "what will happen to the cash?" and secondly that if an investor isn't in a position to control the company their cash value should be discounted, or possibly not even considered at all. Only in the equity markets can an investor convince themselves that $1 is only worth $.80 or $.50 or something less. After my posts on book value, and the discussion at OTCAdventures I think I'm done trying to convince people that assets, and especially cash have value. Instead I am going to continue to hope that people sell their cash to me at a discount, I'll hold it for a while, and then sell for full value, which according to the research happens fairly often.
The company I want to talk about in this post is fairly typical of a negative enterprise value stock. Titanium Holdings (TTHG) isn't a junior mining company, or anything related to metals, they're a pile of cash with a cleaning supply business attached.
The company is located in Texas and operates Cleaning Ideas Corp, a janitorial supply chain. The company's market cap is $1.061m. The company has $1.8m in cash, giving them a negative EV of $800k or so. The company also happens to be a net-net, their NCAV is $2.8m, so they are currently selling for 37% of NCAV, quite a discount.
The company's cleaning supply business makes up a small portion of the company's current assets, about $1m spread across accounts receivable and inventory. The cleaning supply subsidiary also has $250k in fixed assets on the balance sheet.
The company has no earnings to speak of. Last year they had an operating loss of $46k, and the year before an operating loss of $50k. At the rate they're losing money it will take a decade or more before they burn through their cash pile. The company's earning history is spotty, they have years of profits mixed with losses stemming back to 2006, which is as far back as I looked. The company's most recent profits were in 2009 and 2010, where they earned close to $100k each year.
It would be foolish to think the cleaning supply business will ever be anything spectacular, but they might return to profitability in the future. Maybe they eventually sell, who knows.
If we forget about the cleaning supply business we're left with a pile of cash and some marketable securities. The marketable securities are a small foray that the CEO had into attempting to diversify the cash. The pattern of investments shows a CEO who wants to earn some returns, but is afraid to take on too large of a position, the investments are 3% of assets.
There are two questions investors should be asking themselves about Titanium Holdings:
- Is this company really only worth 37% of NCAV?
- Is their $1.8m worth of cash really only worth $1m or less when the cleaning supply business is factored in?
For me both answers are no, and while I don't love the business, I do love the valuation, so I opened a position.
"That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. We know from experience that eventually the market catches up with value. It realizes it one way or another." - Benjamin Graham Senate Testimony 1955
Disclosure: Long Titanium Holdings