Some investors running the rule over Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US), Monitise (LSE: MONI) and Afren (LSE: AFR) could beoverlooking three different but important factors that could negatively impact returns to a greater or lesser degree.
Ive seen many investors reasoning that Lloyds is way undervalued at the current share price of 77p. With the FTSE 100 trading on a price-to-earnings (P/E) ratio of 16, and Lloyds on a rating of just 9.5, surely the bank is a screaming buy? After all, if the company were to be valued in line with the market, its shares would be trading at 130p.
This type of reasoning with Lloyds has been around for a good while. The trouble is, the shares have gone precisely nowhere since hitting 77p in the late summer of 2013. Why so?
Well, the P/E ratio is popular with investors, but an arguably more important measure for banks is the asset valuation ratio of price to book (P/B). Lloyds P/B, based on tangible net assets, is 1.5, which means youre paying 1.50 for every 1 of assets.
Lloyds P/B is already far higher than its FTSE 100 rivals, and if the shares were trading at 130p, the P/B would be a nonsensical 2.5. Even US bank Wells Fargo, the supreme traditional lender, is on a P/B of just 1.8. The P/B, then, is a useful reality check for upside expectations based on Lloyds P/E.
The shares of ambitious mobile money firm Monitise have fallen heavily from a high of 80p just over a year ago. Even after an 11% jump on half-year results yesterday, the price is still only 25p.
The Board said last month that it believes the company has an exciting future as an independent business, but that it is also willing to listen to takeover offers, in light of recent share-price weakness, shareholder feedback and industry developments.
Monitise is loss-making 57m in the first half but has gross cash of 129m, and management is targeting EBITDA profitability (earnings before interest, tax, depreciation and amortisation) in 2016.
If Monitise has recently piqued your interest, and you think it all sounds good, be aware that the company has repeatedly pushed back the date it will become profitable (and switched its target from cash-flow positive to easier-to-achieve EBITDA positive in the process). The original target for cash flow break-even was 2011.
For potentially high-growth companies in new industries, investors rely on managements ability to realistically appraise the businesss prospects and set targets accordingly. If youre looking to invest in Monitise today, dont neglect to factor managements track record into your risk-reward assessment.
Oil company Afren had a market capitalisation of 1.4bn as recently as last year, but with the fall in the oil price and massive debt, the shares are currently trading at 10p, valuing the company at not much more than 100m.
Afrens Board has recently rejected a takeover approach because it was not on terms satisfactory to all relevant stakeholders in the Company, including the indicated value being significantly below the aggregate value of the debt of the Company.
Dont mistake that word stakeholders for shareholders. In this sort of situation, power lies with the companys lenders; in Afrens particular case, the majority of the debt is in the hands of the holders of $860m in bonds. It is looking increasingly likely if not quite inevitable that if Afren is to stay afloat, well see a debt-for-equity swap at a few pence per share at best.
What this would mean is that for every Afren share you buy today, you would have to buy perhaps 50, maybe even more, after a debt-for-equity swap just to maintain your stake in the company at the same level.
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