They can’t be serious. They must be mad!
I stared at the number on the letter again. I squinted my eyes. I looked at it again. But no, I hadn’t read it wrongly. It was the same number I saw the first time around.
You see, a little-known Canadian corporation had just offered me US$268.80 each for my shares of Illumina (NASDAQ: ILMN), a maker of genomic sequencing equipment.
The timing was opportune.
At that point, shares of Illumina were down a painful 20% or so.
And these kindly Canadian gentlemen were willing to take the suffering shares off my hands.
That sounded great.
Except for one tiny problem.
On the same day, shares of Illumina closed at US$305 in the stock market.
In other words, if I wanted to, I could easily sell my shares for 13.5% more right away.
Instead, if I had given up my shares to the Canadian company, they will be making off with an instant gain at my expense.
Ben Graham’s scam
In a way, you could argue that what the company did was just following the wisdom that Ben Graham espoused.
Graham, of course, is widely credited as the father of value investing.
Our new Canadian friends certainly knew the value of Illumina’s stock — that’s the current stock price that can be easily looked up — and decided to pay a price that was lower than its value.
To be sure, it’s not illegal.
They are not forcing you to sell.
They’re making an offer. It’s up to you, the investor, to accept or decline the deal.
But it sure feels slimy.
Scared investors who have been hit by a 20% share price haircut may make an emotional decision to sell out of fear, not reason. Especially if they have not been looking at the day’s stock price.
If the value of the stock is known, any reasonable investor will make the immediate decision not to sell to the Canadian corporation.
That said, putting a value to a stock is not always as easy as what we see here.
Knowing the value of a stock
Graham’s advice on paying a lower price is simple to understand.
But it is hard to execute.
As individual investors, we can’t do mini-tenders like our Canadian friends. Nor should we.
What we have is the stock price that we all can see. From there, we have to determine whether the underlying value is worth more or less than its price tag.
Putting a value to a stock, though, is not a simple exercise.
Every company has many moving parts that make it impossible to predict with accuracy, a correct value. Even when you do, you are unlikely to be consistently right.
At best, we can make an estimate — but even then, there are other factors at play.
Valuation is also about predicting the future.
It’s not as simple as looking at track records.
A growing company may have done well in its first decade of operations. However, it could still stumble when competition, which is attracted by its profits, floods the market with lower prices.
It’s also not as easy as looking for hard assets to back up a company’s value.
A prospective company may have plenty of hard assets and cash. However, if its management squanders the company’s assets, and misspends its money, the company’s value could eventually disappear.
That’s not all we have to consider.
The real value of a company can also be hidden.
When I bought shares of Amazon.com (NASDAQ: AMZN) nearly a decade ago, I had no clue that its Amazon Web Services (AWS) was going to be big as it was today.
In fact, until the company split out its AWS segment in 2015, I reckon that few investors, in any, knew.
Today, the operating profit from its AWS business is higher than all the other segments combined.
I doubt that any investor put that in their excel spreadsheet.
Your personal valuation toolkit
When I first bought Amazon.com shares, I didn’t know that AWS was going to be as big as it is today.
But I did recognise the type of company Amazon was — an innovative one.
By recognising the type of company, I can pick the appropriate valuation approach for its particular type.
When it comes to companies with open-ended, positive futures, I tend to let the company run.
Amazon, in my view, is one such company where its hidden value remains abundant.
To state the obvious, it will be foolish to sell an Amazon-like stock too early and miss out on the gains that followed.
For some numbers behind my assertation: I bought my Amazon shares in 2010 at US$120.05. At the end of 2014, shares had risen to US$310.35, providing me with returns of around 160%. At that point, the size of the AWS business was yet to be revealed.
Today, shares trade at above US$1,750, lifting my returns to well over 1,350%. AWS played an obvious role here.
Level up
Along that vein, I think that focusing on the stock price alone would be incomplete.
In my view, the price you pay is only one factor. There’s also portfolio management to consider.
Thinking at a portfolio level opens up a whole new repertoire of tools at your disposal.
You can decide which stock fits into a particular segment in your portfolio.
You can also choose to control the size of your stock position. Or you can choose when you should add to the stock and when you should hold off.
The factors above, along with the share price that you pay, could tilt the odds to your favour in getting satisfying returns.
Stay tuned. We have plenty to share in the months ahead.
Get Smart: The Illumina epilogue
As we speak, shares of Illumina are back up to above US$325.
I still hold my shares today and haven’t sold.
For the record, it’s not because I knew that shares would recover within months. Far from that.
Instead, like Amazon, I believe that the Illumina’s future could expand in so many unpredictably positive ways, much of which we cannot begin to see.
When it comes to valuation, I want to leave room for hidden values to be revealed.
That means having the patience to watch its business grow, stumble and grow again.
To use an analogy to bring home my point …
When we cook with high-quality ingredients, our cooking technique does not have to be top-notch. The quality of the ingredients will eventually shine through, so long as we don’t mess up the cooking process.
Likewise, I believe that I am starting with a good ingredient with Illumina, and I don’t see why I should mess around with its shares.
If I am right, the company’s real value will eventually be unlocked, and be recognised by the stock market in the long run.
Until then, I’m quite happy to hold and watch the future unfold. Onward.
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None of the information in this article can be constituted as financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Disclosure: Chin Hui Leong owns shares of Amazon and Illumina.
