[Editor’s note: This letter was penned by Tim Staermose, Sovereign Man’s Chief Investment Strategist and editor of the 4th Pillar Investment Alert.]
If you know me personally, you know I have a lot of hair.
So when I go get a haircut, I always feel bad that the price is the same for me as for people who are almost bald… so I tip accordingly.
Recently when I went for a long-overdue haircut in Bali, I paid about US$1.50, plus a generous 50% tip of roughly 75 cents.
Ahead of me in line was an older European gentleman. He went for the works. Haircut, shave, and scalp massage. His total cost: about US$3.80.
It got me thinking about trading, investing and the relative value of things.
The same service at the barber in Europe, Australia, or North America would undoubtedly have cost 10 to 20 times as much.
So, this was clearly fantastic value – right?
Well, I would argue that it actually depends on your yardstick.
Here in Indonesia an average wage can be as little as $150 to $300 a month. So a $1.50 haircut represents about 0.5% to 1% of the average monthly wage.
In the US, the average monthly wage is about $3,900 according to the Department of Labor. 0.5% to 1% is $19.50 to $39.
That’s more or less what a haircut will cost you in the US, depending on where you live.
So as it turns out, in both the US and Indonesia, a haircut runs 0.5% to 1% of average monthly income.
So, while I’d argue that my haircut in Bali was very good value in ABSOLUTE terms, in RELATIVE terms it wasn’t a screaming bargain after all.
Fortunately (or deliberately arranged that way, actually), my income is earned entirely overseas, at “rich economy” rates.
So for me personally, the cost of living in Indonesia – including haircuts – is an absolute bargain.
That brings me back to investing: professional money managers often seek investments that offer good relative value.
A stock might be cheap relative to its competitors. Or it might be cheap relative to its historical trading range.
Or, it could be cheap relative to alternative investments like government bonds.
But who cares if a stock is ‘relatively’ cheap if everything you compare it to is expensive?
It’s not particularly good value to buy a stock that’s slightly less overpriced than its competitors.
That’s the problem with most mainstream investments nowadays; they’re only being viewed in relative terms.
In absolute terms, stocks in most major markets are incredibly overpriced.
Thankfully, as small individual investors, we can think for ourselves. In seeking independent forms of income, we can look across the world for the best bargains to find absolute value.
In particular, we want to buy shares in companies that are screaming bargains.
One of the most lucrative corner of the market for me has always been companies that are selling for less than their ‘net cash’ in the bank.
(Net cash refers to the company’s bank balance minus any debt.)
I have always found that if you can buy such a company and have a modest degree of patience, almost invariably you can make a very nice profit.
Sometimes this happens quickly.
This was the case with a company called Queste Communications (QUE on the Australian Securities Exchange) that I made a small fortune with back in 2003.
It was just after I’d bought my first house. So I only had about A$14,000 of savings left to my name. I put ALL of it into Queste.
It was a small technology company whose shares had crashed in the dot-com bust.
The crash was so deep that the company’s stock price was about 4 cents; yet the amount of cash it had per share amounted to 14 cents.
So by buying the shares, I was spending 4 cents to purchase 14 cents in cash.
Needless to say I bought as many as I could afford. Within a few months the stock price had more than tripled (and even then was selling below its cash backing).
In all, I got back A$51,723.21 on a A$14,000 investment. Not bad for a small-time investor, as I was back then.
These sorts of deals have been my focus for years and comprise the majority of our recommendations in the 4th Pillar Investment Alert.
Right now I’m finding the Australian market to be fertile hunting grounds.
My methodology is slow and deliberate; my research team and I pour over hundreds of companies’ quarterly reports; you can find these yourself on the ASX website.
It takes a lot of time, but after going through those reports, we uncover all the gems… well-managed companies that are selling for less than their bank balances.
There’s a LOT more analysis that goes in to the decision to find our top recommendations…
… but, broadly, this should give you a basic understanding of our approach and how you might be able to apply it to your own investments to find incredibly lucrative ABSOLUTE value.