One of the best ways to score a bargain when shopping is to trawl through the bargain bins and sales items to find something of good quality selling much cheaper than normal.
Trying to find unfashionable bargains on the share market is just the same – you are looking for that diamond in the rough, a company that is trading well below its normal price that will perform well under any conditions, particularly when times get tough.
Frothy markets which are testing new limits for many companies are a perfect time to raid the bargain bins, when a lot of tried and tested stocks are discarded in favour of something shiny and new.
No Doubt Markets Are Frothy
If you doubt that markets are frothy, the fact that recently 19 of the companies in the ASX 200 had total returns of 100% or more for the year to date should allow time for a bit of a stocktake.
The question investors need to ask before hitting the bargain bins is “what would happen if the market took a turn for the worse?”.
The answer is that some of these frothy valuations will return to sanity with a thud while some of the proven but “boring” and “out of favour” stocks will come into their own.
I’ll look here at just one good example but there are many more to find if you are prepared to rummage a little and look past the flash and excitement of the next big thing.
The company in question is ++Australian Foundation Investment Company (ASX: AFI),++ and the hidden value you can uncover is there for all to see.
Trading at a Big Discount
In its latest statement of net tangible assets, AFIC reported that its pre-tax net tangible assets were $8.22 a share and its share price (on October 10) was $7.40.
Since then, the share price has fallen a little but what this comparison shows is that AFI shares are trading at an 11% discount to what they are intrinsically worth.
I think the best way to describe AFI is as a curated ASX 200 long term shareholding company with a strong emphasis on delivering franked dividends.
During boom times – such as now – the more conservative management of AFI leads to underperformance because every Tom, Dick, and Harry is certain they can beat a boring listed investment company by buying whatever is hot and hanging on.
That was shown when AFI management decided that Commonwealth Bank shares – which it holds a lot of in its $10.2 billion portfolio – continued to defy gravity on price earnings and dividend yield measures and they sold some.
That sale made it harder for AFI to keep up with the total return indexes like the ASX 200 Accumulation Index but was perfectly justified for a long term, value-based investor that needs to rebalance its portfolio by selling high and buying low.
The sale also generated a tax payment which is now stored up with all of the other franking credits within AFI and will return to investors as a franked dividend.
What Happens During a Market Hiccup?
What is interesting to consider is what happens when there is a market hiccup and the “go for growth” momentum trade stalls.
That happened in the period in which US President Trump announced his Liberation Day tariffs and the discount between AFI’s net tangible assets and share price quickly closed to 5%.
In a fully blown bear market you would probably see that switch to a premium as the value of having a reliable, fully franked dividend payment and a wise value manager at the helm becomes an advantage rather than a drag on returns.
Very Low Fees
The other thing to consider is that despite being a listed investment company, AFI’s management expense ratio is very competitive with many exchange traded funds (ETF’s) at just 0.16% and arguably the active portfolio management is superior to a passive computer approach in the long run.
With a 97-year history and an amazing dividend record, it seems like a great time to fossick around in the bargain bin for some AFI shares.
After all, it is not every day that a quality product is available at effectively 10% plus off the “normal” retail price.
