As we are all aware, the stock market is made up of thousands of companies. Some good, and some not so good. Today, I plan to take a look at three companies. Before I do, I want to share one of the most famous quotes from an investing legend: Mr Benjamin Graham, the father of value investing. Graham wrote:
The owner of equity stocks should regard them first and foremost as conferring part ownership of a business. With that perspective in mind, the stock owner should not be too concerned with erratic fluctuations in stock prices, since in the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine
What exactly did he mean by this? Well, in simple terms he meant that the true value of the company will, in the long run, be reflected in its stock price. Now, lets take a look at those three companies
Gate Ventures (LSE: GATE) is a company formed to make investments and capitalise on investment opportunities in the media and entertainment sector, focusing on the theatre production and the music industry. It listed on the alternative investment market (AIM) on 10 March 2015 at 10 pence per share. It currently trades at around 182 pence per share thats not a typo! for a market-trouncing gain. So what has happened to this company in such a short space of time? Frankly, other than a small investment in a play to be staged outside of the West End, I cant see the reason behind the rise, other than a little too much excitement.
Some quick calculations reveal that, following admission to the market, the company raised just over 3 million, which equates to around 9.4 pence per share. To my mind, that means that the company currently trades on almost 20 times its book value. To put that into context, Berkshire Hathaway shares trade on around 1.4 times book value. To me, this unproven company looks exceptionally overvalued at current prices.
Not much has changed since I last took a look at Afren (LSE: AFR), with the company heading towards its refinancing at the behest of its bondholders. The chart below captures this sorry tale as the company was hit by a perfect storm of irregular payments at the very top, followed by an oil price crash, and topped off with huge asset writedowns.
So why do I think that the shares are overvalued? Well, there are two main reasons:
- The main issue, for me is the huge dilution that is about to hit equity shareholders. Even if they take up their rights in full, they will own significantly less of the issued share capital than before.
- Next up is the huge debt pile. My fear here is that the company seems to have agreed to a deal with the bondholders that involves it taking on further debt at higher interest rates. I wouldnt be surprised to see a further default down the road, especially with oil at these prices.
I think that the shares will continue to slide as Mr Market starts to price in the dilution that will see shareholders carryheavy losses.
Gulf Keystone Petroleum
As any shareholder in Gulf Keystone Petroleum(LSE: GKP) will be able to attest, this company has been a serial disappointer. Investors would need nerves of steel to ride this roller-coaster just look at the chart, which shows how things can turn in the stock market.
In a similar vein to Afren, this company is struggling to service its debt. If that wasnt bad enough, it is doing its business in one of the most dangerous places in the world and facing difficulties collecting payments for the oil that it produces, and Mr Market has marked the shares down accordingly.
So What Is Going On Here?
Personally, I think that it is quite simple. Going back to the market acting as avoting machine, I think thatthis is currently the case with Gate Ventures: with investors rushing in to buy shares, the market votes them higher. In the case of our two oil companies, the market is starting to act as aweighing machine,with the shares being marked down as reality starts to hit home. Personally, I wouldnt be surprised to see them marked down further from here.
Clearly, there will be some investors sitting on handsome gains, whilst others nurse their losses.
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Dave Sullivan owns shares in Berkshire Hathaway. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.