Piet Viljoen: Finding the hidden gems on the JSE

One of the speakers at the BizNews Investment Conference, Counterpoint value fund manager Piet Viljoen explains the concept of value investing and where pockets of opportunity can be found on the Johannesburg Stock Exchange.

Piet Viljoen on hidden gems and what not to look for:

To define what we’re looking for, I think it’s best to start [with] what we’re not looking for. We’re not looking for this sort of thing – digital art. It doesn’t exist in the real, tangible world. An NFT – a non-fungible token was sold for $69m at a Christie’s auction last week. This is exciting. People were bidding ip to $69m – which is the third highest price a living artist has ever received on auction – for a NFT (which lives on the blockchain) for a piece of digital art which doesn’t exist in real world. That’s exciting, [but] that’s not what we’re doing. We are not buying NFT’s at $69m. 

Investing in hidden gems:

To invest in hidden gems, you need the following:

1.) You need to have done at least some original research.
2.) You need to have read the annual report to see who issued these preference shares (which entity issued them) to see that these preference shares pay cumulative dividends – that they can’t withhold dividends.

You need to do these fairly simple things. You can’t rely on other people because, [everyone else] is focusing on the top shares in the market that are well researched by the sell side, that everybody knows about. There’s no secrets there. That’s the first thing you need to do. The second thing is you need to be comfortable with disgust.

You need to have a strong constitution to buy Steinhoff preference shares, you need to be comfortable taking on the disgust at the moment. If you think back to December 2018 – what the emotions were at that time – it was not pleasant. You need to be able to deal with that. You need to be able to accept illiquidity, hidden gems by definition are hidden. Nobody’s looking at them. When I say nobody, I mean the sell side. The stockbroking analysts are not looking at them because there is no brokerage here. They are illiquid. They don’t trade a lot. There’s no brokerage, there’s no incentive for the stockbrokers to analyse these companies. That’s why they’re hidden and that’s why they’re undervalued.

On going against the consensus:

You need to be able to go against a strong consensus. The reason it’s undervalued is because of all these emotions, [plus] there’s a strong view out there that something is wrong with this business. You need to have done your work and to be able to have the constitution to go against that strong consensus.

On understanding optionality and digesting failure: 

You need to understand optionality and be able to live with optionality. Generally, when one looks at these hidden gems, they act like call options – you pay a premium and there can be a tremendous upside or it could go to zero. You need to understand the pay-off profile of a call option (because that’s generally what you’re buying) and you need to be comfortable with that.

Finally, you have to be able to digest failure. A call option can go to zero. You pay your premium and if the underlying doesn’t work out, it goes to zero after a certain period of time. When you’re looking at these hidden gems, some of them are not going to work out. That should be your point of departure and you should build that into whatever you are doing and thinking. Some of them are just not going to work out.

On investing in South Africa:

Nobody wants to invest in South Africa anymore. Everybody is taking their money offshore. It’s much more fun investing in Alphabet, Apple or Facebook than it is to look around the JSE – in this failed economy of ours – for investment ideas. Everybody is going offshore. That’s clue number one, that there might be some good prospects available here in South Africa, because nobody’s looking here.

A vector to look at – if nobody is looking – is at companies that are trading below current net asset value. In other words, liquidation value. You take current assets on the balance sheet of the company, those assets that can be easily turned into cash. Stock, creditors, investments – those sorts of things. You ignore long-term assets like property or machinery. Just look at current assets and you deduct from current assets all the liabilities of the business – tax liabilities, long-term debt, short-term debt. You’re left with what’s called a net current asset value. Today on the JSE, I can find at least eight stocks that are trading below that value, where the market value is below liquidation value.

On Lewis stores, as an example:

An example is a company called Lewis Stores. It’s a good business [and] it’s doing very well at the moment, but the market has completely ignored it. It is trading at less than liquidation value today. That’s one type of company. The second type of company one could look at is investment holding companies, where the market has just given up on them. They’re trading a big discount to net asset value. Rembrandt is an example of a company that used to trade at around net asset value, today it is trading at a 20% discount. But I don’t think that’s good enough. That’s not a hidden gem, that’s a slightly undervalued situation.

On what a hidden gem is:

A hidden gem is an investment company, whose net asset value per share has outperformed the All-Share value over the past 20 years. [A company]that you can today buy at 40% of net asset value.

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