The S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) has now dropped more than 5% in the last month, bringing stock valuations into a reasonable range. Warren Buffett has spoken highly of the GNP to total market capitalisation ratio as a measure of whether a market is overvalued or undervalued. I performed an analysis of that measure in August last year and my results suggested that the Australian market was slightly overvalued then. Since August the total domestic market capitalisation has been swelled by IPOs. It's no surprise that so many companies chose to list when the market was overvalued by most reliable measures.
By my reckoning the market certainly isn't undervalued yet, so I wouldn't be surprised if stock prices continue to head south over the coming weeks or months. The prospect of this excites me, as Mr Market may be on the verge of offering decent prices for some of my favourite companies. Here are three approaching attractive prices.
Bentham IMF Ltd (ASX: IMF) is a litigation funder that has recently expanded into the US. Basically, it funds litigants who need to sue companies (or governments), but lack either the means or the will to fund their own action. IMF funds and manages the litigation for them, and takes a cut of the winnings (if there are any).
I bought shares in the company a few months ago at $1.70, but recent news that IMF was successful in only one of five claims against Australian and New Zealand Banking Corporation (ASX: ANZ) has pushed the share price below my purchase price. Opinions differ as to whether this is a good result or not, but I say the result is a poor one for the litigation funder, as its successful claim – that "late fees" are an unconscionable penalty and a breach of contract, was considered highly likely to succeed from the outset. Success in the other four claims (for different types of fee) would have provided cream for the company.
However, it is typical of the litigation funder to undertake an action that has a high prospect of success. The more difficult arguments surrounding the other fees would have come at a relatively low incremental cost. As long as the judgement regarding "late fees" sticks, Bentham IMF stands a decent chance of settling claims against other major banks – a result that minimises expenditure, and therefore risk to the company. Bentham IMF isn't in "no-brainer" territory, but I welcome the company in my portfolio, as demand for its services is reasonably uncorrelated with the rest of the economy.
Regular readers might have figured out that I'm obsessed with owning a share of the fibre optic infrastructure that's an increasingly important part of the telecommunications' backbone of our economy. TPG Telecom Ltd (ASX: TPM) with its impressive fibre optic network, is therefore a company to which I hope to gain greater exposure. For a very long time, the company has been richly priced, but its share price has fallen 8.2% in the last five days and I'm willing Mr Market to push the price further down.
TPG Telecom is run by the strategically brilliant David Teoh. The company seems destined to exploit politicians' ineptness and plans to connect the fibre network to the profitable and densely populated areas that should have been the first areas addressed by NBN Co. If ever there were an instance where private enterprise puts government to shame, this is it.
Finally, GBST Holdings Limited (ASX: GBT) sells back-end software for the financial services industry, and therefore claims one of my favourite qualities: sticky recurring revenue. The company generated at least $13 million in free cash flow in FY 2013 and I think it has a reasonable chance of growing that to about $17 million in FY 2014.
One drawback of GBST is its large intangible asset on its balance sheet, although they are amortising that at a reasonable rate. One short-term catalyst for a higher share price might be a reduction to amortisation, which would boost NPAT, thus drawing the company to the attention of the "P/E ratio crowd." Non-cash accounting adjustments such as amortisation and depreciation can act to disguise the cash generative qualities (and profitability) of businesses such as GBST.
The company has seen some director selling in the last 12 months, but insiders still own a decent chunk of the company. GBST Holdings has fallen more than 15% in the last month, and should market pessimism drive it down another 15%, I'd almost certainly start buying shares, even if I had to sell other holdings, all else being equal.
Foolish takeaway
As market sentiment turns, it's time to get greedy. The challenge for investors is find the most fearful, most irrational sellers of high quality shares and buy them with a smile. As people watch the share price drop, it triggers pain censors in their brain, and one way of making the pain stop (perversely) is to sell declining holdings. Think of yourself as a professional pain reliever rather than a victim, but if you have that pain yourself, make sure any sell decisions are rational capital allocation rather than an expensive form of pain relief. I write this to remind myself as much as anyone else!
