The first step to finding undervalued small caps!

It lies in something called nett asset value…. But when you go down the investing rabbit hole of financial ratios and jargon you are likely to encounter acronyms like NAVPS and SOTPS. So today’s article is all about explaining NAV and SOTP and what if any is the difference between these two metrics. And how to use it to find undervalued small caps.

Let’s start with a simple explanation of what NAV (Nett Asset Value) is and how to calculate it?

Let’s say you own a R1.5 million house and a R300,000 car… Then you own assets worth R1.8 million.

And let’s say you borrowed R1 million from the bank to pay for them. That means your liabilities are R1 million.

Now, if you subtract the liabilities of R1million from your assets of R1.8miilion, this leaves you with R800,000. i.e. If you sold everything and repaid your debt you’d be left with R800,000.

That in other words, is your Net Asset Value.

It works the same way with companies listed on the stock market…

If a company owns properties, equipment and inventory worth R200 million, and it owes the bank and its creditors R80 million, it has a net asset value of R120 million.

The key difference between a company’s net asset value and your own personal one is a company’s can be calculated on a ‘per share’ basis.

For instance, if the same company (worth R120 million) had 60 million shares in issue – its net asset value per share would be R2.(R120m divided by R60m)

So, what does this tell you about a share?

Well, a company’s net asset value per share needs to be compared to its share price to mean anything…

So, if you know the NAV of a share you can compare it to its share price.

If the NAV sits at R2 whilst the share price is R1.20 – it means the share is trading at a discount to NAV. A 40% discount to be exact. (R2 -R1.20 = R0.80 . Divide the R0.80 into the R2 and x100 = 40%)

If the NAV sits at R2 and the share price sits at R2.50 – it means the share is trading at a premium to NAV.

Of course, it doesn’t mean you should buy a company’s shares just because it’s trading at a big discount to its NAV per share.

You have to consider other factors like whether the company is consistently growing revenues/profits. If it’s debt-free or if not, and managing its debt well. If it consistently generates sufficient cash flows.

My point is – the NAV per share gives you a starting point to find out whether a stock is undervalued relative to its share price.

It’s a metric I use all the time particularly when scouring the small cap space.

Is the sum-of-the-parts (SOTPS) the same as NAV per share?

When reading a company’s financials, you might come across something called the ‘Sum of the parts’.

Typically, you’ll find this phrase while reading investment holding company’s reports. And it refers to the value of each investment held by an investment holdings company – minus the liabilities (or debt).

In short – it is a way to put a value on a company based on the value of each of its separate businesses if they were sold or liquidated. So, the SOTP tells us the same story as the NAV per share.

The only difference is you’ll mostly find investment holding companies use this value metric. That’s because holding companies rather invest in many different companies operating in various sectors. They make their money from dividends, and from capital growth by selling the businesses they invest in.

And even after a post-GNU rally in SA stocks, there are still a number of investment holdings companies selling at large discounts.

The fact is some companies are going for so cheap, you simply cannot ignore them.