Most stocks with long histories trade within spitting distance of intrinsic value most of the time. Newly listed spin-offs are less predictable, at least for a while. For the first few months of their listed life, they’re more likely to be overpriced or underpriced than the typical stock.
This happens for a variety of well-documented reasons. Perhaps the most important one is price-insensitive selling by those who received shares and either want to, or must, sell.
The Forager Australian Shares Fund holds a small position in recent BHP Billiton spinoff South32. It looks cheap, and we suspect it’s because of unthinking selling by institutions.
Last weekend, Steve and I had lunch with an analyst for a big European fund based in the Netherlands. The fund owns both Rio Tinto and BHP, justified by both companies holding major offices in the UK.
When South32 spun out of BHP in May, his initial thoughts were to hold the stock, get to know the assets and make a reasoned decision on whether to continue to own it.
But, soon after the stock popped up in his portfolio, he got a call from risk management. They said South32 had no business being in his portfolio—yes it has a UK listing but it has no physical presence there. This dyed-in-the-wool value investor had no alternative—he was forced to sell before he’d even picked up the prospectus.
A few days earlier, we were told by a UK fund manager that many UK funds are in the same boat, with sell decisions driven by mandate restrictions or risk management diktat rather than careful analysis. This explains the large number of substantial shareholder notices being lodged on the ASX as fund managers sell the stock. It’s music to our ears.
This, of course, doesn’t guarantee the stock is cheap. Perhaps there’s an equal weight of smart money coming in to offset the blind selling. And, even if not, things can still go wrong. Perhaps we’re at the start of a 20-year commodity bear market where mineral prices average much lower than today’s already deflated prices, making today’s sellers accidentally lucky.
There are no guarantees in investing. But spinoffs are as good a place as any to be hunting for bargains.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.