Buying wonderful companies at fair prices is the mantra of Warren Buffett. But this is not how he has always been. Buying fair companies at wonderful prices is how Buffett started – a skill he learnt from Benjamin Graham.
Buffett refers to this approach as the cigar butt approach. It entails a focus on valuation in isolation of quality and growth.
Recently, in his book the Acquirer's Multiple, Tobias Carlisle has argued that simple mean reversion is the catalyst and primary reason for buying cigar butt companies.
Carlisle has also demonstrated that (unless you are Warren Buffett) buying companies solely on valuation is more profitable than buying on a combination of price and quality. This difference is equal to millions of dollars over several decades. So where are the fair companies available at wonderful prices on the ASX today?
To find companies currently trading at wonderful prices, I have sorted ASX stocks over $300 million in market capitalisation by their Sonkin Ratio. The Sonkin Ratio is a robust version of the Price to Earnings ratio. The Sonkin Ratio is simply the Enterprise value of a company divided by its operating earnings adjusted for tax. It can be expressed as:
Sonkin Ratio = (Market capitalisation – Cash + Debt) / EBIT(1 – Tax rate)
The Sonkin Ratio is the multiple of tax-adjusted operating earnings an investor would pay for the stock. Or, how much an investor would have to pay for every dollar of operating earnings.
Here are 10 of the cheapest companies on the ASX and their Sonkin Ratios.
HT&E Ltd (ASX: HT1) – 3.05
Resolute Mining Limited (ASX: RSG) – 5.18
Retail Food Group Limited (ASX: RFG) – 6.80
Fortescue Metals Group Limited (ASX: FMG) – 6.90
Seven West Media Ltd (ASX: SWM) – 7.94
Myer Holdings Ltd (ASX: MYR) – 8.36
Sky Network Television Limited (ASX: SKT) – 10.31
Washington H. Soul Pattinson and Co Ltd (ASX: SOL) – 10.64
St Barbara Ltd (ASX: SBM) – 10.99
BlueScope Steel Limited (ASX: BSL) – 11.24
Foolish takeaway
These are 10 of the cheapest stocks on the ASX over a market capitalisation of $300 million. Of course, there are many and varied reasons for why they are cheap. Distinguishing between those that represent bargain prices, and those that are companies in terminal decline is the difficult part. It helps if you are Warren Buffett.
