While there are thousands of different stocks to invest in, most well-known investors such as Warren Buffett and Peter Lynch choose to categorize stocks. An asset play is a form of categorizing a stock whose assets are worth more than the market cap of the stock.
In this guide, we will cover all the questions and topics about asset plays, and how investors can look for this type of stock.
What is an asset play?
An asset play is a type of stock whose market capitalization is worth less than the company’s total assets. Asset play stocks are a common type of stock that value investors look for, in which there is a margin of safety since the assets of the business are worth more than the business.
Investing in an asset play is a form of arbitrage, where investors take advantage of the lower value of the company’s market capitalization relative to the assets it owns. In the hope that the market will realize the discrepancy, and bid up the stock price.
Who coined the term asset play?
The term asset play was first introduced by Peter Lynch, who has been one of the most successful fund managers. During the years that he ran the Magellan Fund, Peter Lynch invested in several asset play stocks, achieving a 29.2% annualized return. Making him one of the most successful fund managers on Wall Street.
In his book “One up on Wall Street”, Peter Lynch mentions the term asset play and describes in detail the investment thesis behind this type of stock.
Types of asset plays
Asset play stocks can be divided into different types depending on the undervalued assets the company holds.
In some cases, a company owns a lot of properties that are still valued on the balance sheet at the purchased price. Sometimes years have gone by, and the value of that real estate is now much higher. These are attractive types of asset play to invest in, but they do require more research into the company’s real estate portfolio.
Some companies also have a lot of investments in other companies and businesses. It is also common for the value of their investment to not be reflected in the total market capitalization.
In these cases, there is a clear opportunity, because the market is already valuing the other business, and the current valuation of the company is not reflecting the value of its investments or stakes in other companies.
Cash and equivalents
Finally, there are also certain companies whose market cap is lower than the current assets of the business, or its cash and equivalents. This type of asset play is far more uncommon, and it shows that the company is not deploying the capital.
Additionally, it can also show that the management does not have the best capital allocation strategy in place. Despite that, there is a clear arbitrage opportunity in these types of asset play stocks, and you should try to look for them.
A conglomerate that owns several businesses can also be an asset play. In some cases, the market will value the different subsidiaries completely differently, and since there is a single entity that owns all of these businesses, the valuation might not be reflective of the intrinsic value of the company.
In such situations, the best option is to spinoff subsidiaries, in the hopes that the market will value them at higher multiples than the conglomerate.
Unlocking value in asset plays
Asset plays can be very profitable investments, but it might take time for the market to react and close the gap between the company’s asset value and its market cap.
When you invest in an asset play stock, you have to wait until the market finally realizes the total value of the company’s assets is worth more than its market capitalization. Most of the time, management in asset play stocks is well aware that the company has a higher value than what it is trading at, and might even conduct buybacks, or it is also common to see insiders buying shares.
To try and reflect that value on the stock price the management can spinoff some of its subsidiaries. This is a common solution to the problem, although it does not always work.
A common scenario is that companies that are slowly growing, might have a subsidiary that is growing faster than the parent company. This is a perfect example of a great situation, where management tries to spinoff the fastest growing subsidiaries, in the hopes that they will have a higher valuation.
Asset play examples
One of the most remarkable examples of this kind of situation was the Paypal spinoff. eBay, which owned Paypal at the time, saw steady but slower growth in its marketplace.
Paypal on the other hand was growing exponentially. Carl Ichan, a well-seasoned activist investor noticed it. He proceeded to acquire a significant position in eBay so that he could have some presence on the board of directors. He pushed for the spinoff of Paypal, which would later become the major company that we know today.
Another example of an asset play is Softbank, which owns a considerable stake in Alibaba, and well-known companies. If we add the corresponding value of Softbank’s stakes in other companies and deduct it from the market cap, we realize that it is trading at a discount to its assets.
On top of that, we still have the underlying business in Japan, which is also a valuable asset. The efficient market hypothesis explains this discount because it is unpredictable how the company will manage those assets. However, there seems to be a clear opportunity for value investors to take advantage of.
Naspers, a South African company was one of the early investors in Tencent. Nearly two decades have gone by, and that initial investment has turned out to be perhaps the best investment in the century.
Naspers encountered some problems, despite all of the success of their Tencent investment. Its stake in the company was not fully recognized in its stock price. For a long time, Naspers was trading at a lower market cap than the whole value of its Tencent stake.
And Naspers still has a very interesting underlying business and several other investments. Naspers' market cap has grown so much, that it was a key part of the South African exchange, where it trades. Naspers had such a weight on the index, that a significant move in price could affect the index’s performance tremendously.
In an effort to try to get the market to value the company closer to its real value, the management decided to create a new entity, Prosus, that would hold part of its Tencent stake. It would also trade separately from Naspers. Although the efforts were well intended, and the Naspers valuation increased, it still trades at a discount.
Advantages of investing in asset plays
Here are some of the best advantages of investing in asset play stocks:
Margin of safety
One of the best advantages of investing in asset plays is that there is a margin of safety. This is the difference between the asset value per share and the price per share. This makes it more likely for investors to make money, as other market participants realize the relative undervaluation of the stock.
Value stocks are more likely to outperform
Value stocks are more likely to outperform growth stocks over the long term, and this is another advantage of investing in asset plays. Although this is not always the case, the likelihood of having higher returns is historically higher.
Difficult to lose money
Asset plays are also a safer type of stock because the likelihood of losing money is low. Since you are buying a stock whose value is much higher than the price you are paying, the probability of losing money becomes lower.
Disadvantages of investing in asset plays
The value may never be unlocked
One of the major disadvantages of asset plays is that they require the general market to change their view on the company’s value. This may in fact never happen, and in some cases, stocks trade at a discount to their fair value for years.
The company might run into future trouble
Another important aspect is that the company might run into financial trouble. This is especially true when investors focus too much on the value of the company’s assets and fail to see the declining business behind it. The market is not always efficiently pricing each stock, but most of the time there will be plenty of reasons why a certain stock is trading at a discount to its asset value.
You should not focus entirely on the assets of the company, because after all there is a business that needs to perform well for the stock to rise.
The assets may decrease in value over time
If you hold an asset play for a long time, there are some cases where its assets may decrease in value over time. Consider for example a company that has invested in other companies whose valuations collapse. Or a situation where a company is holding a lot of cash, and inflation is running very high. In these cases, you might actually lose money on an asset play.
Returns can be lower than expected
In some cases, the returns can be lower than expected, in the sense that even if the value of the assets is unlocked, it may not be fully unlocked. It is not uncommon for asset plays to increase in value and still remain relatively undervalued. So keep that in mind if you are planning on value investing in asset plays.
Asset plays can be very profitable investments, even if they take some time to materialize. They offer enough margin of safety, due to the asset value being higher than the total market cap.
Although this is one theme, within value investing - it can be combined with other ways of finding value stocks. You can also invest in an asset play that is also trading at a discount to its future earnings.
An example of this is CK Hutchison, which we analyzed recently. CK Hutchison is still trading at a discount and it might take a while more before the market finally agrees with us on this one.
Remember that due diligence is the key to investing in asset plays because you need to accurately identify the undervaluation of the stock. . Being able to clearly identify the unappreciated assets, will also allow you to have a better idea of what can happen so that value is unlocked.