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How I Find Cheap ASX Shares

What constitutes ‘cheap’ on the share market will be subjective to each individual, dependent upon the mode of valuation used and one’s opinion of the future financial performance of the company.

The Concept Of Book Value

One commonly used method for identifying shares trading cheaply is to compare the net assets of the company, its book value, with the share price. This is often referred to as the price-to-book (P/B) ratio. If the shares are trading for less than the per share book value, it can be a strong indicator that the shares are cheap.

An even more extreme measure is to compare only the net tangible assets (NTA) per share with the share price, thus excluding accounting assets such as ‘goodwill’ and intellectual property (IP).

These asset based valuations were a favourite method of Benjamin Graham, sometimes referred to as the father of value investing and arguably the greatest influence on investing legend Warren Buffett.

Boom And Bust Nature Of The Share Market

During economic booms share prices become inflated, pushed up by the collective positivity of investors which creates a dearth of opportunities to pick up shares trading below their NTA. Typically, opportunities will be most prevalent in asset heavy businesses that operate within a cyclical industry.

During lean times assets become under utilised. As a result, the return generated from the assets can fall significantly, and with it, the share price too.

In the short term, the share market is a popularity contest where companies involved in the latest fads and trends are often bid up to fanciful valuations. However, in the long run the share market is much more rational and a company’s share price will eventually reflect the profitability of the underlying business.

For the patient investor, selectively buying shares in companies trading below their NTA during the lean years can prove to be a very lucrative investment strategy when the tide inevitably turns.

Where To Start Looking

The mining services industry has been a bargain hunters paradise at different stages during the past decade. Mining is a cyclical industry which goes through booms and busts, however investors often act as if the current times, whether good or bad, will go on forever. It’s during the lean years, where these shares are unloved by investors, that a bargain can often be found.

Some investors have done extremely well out of investments in mining services companies like NRW Holdings Limited (ASX: NWH) and Macmahon Holdings Limited (ASX: MAH), both of which traded at a discount of more than 75% to their NTA at times during 2015.

Three ASX Shares Currently Trading Below NTA

It is important to understand that just because a company’s shares can be purchased for less than NTA, it does not automatically imply that you should do so. It is by no means the only factor in a well conducted analysis but rather a catalyst for more detailed investigation.

Furthermore, I’d suggest taking a portfolio approach whereby I’d invest in a handful of such companies rather than pinning my hopes to just one.

With that said, three ASX shares that currently fit this criteria are MMA Offshore Ltd (ASX: MRM), Matrix Composites & Engineering Limited (ASX: MCE) and Boom Logistics Limited (ASX: BOL).

All three operate in the mining services industry and have been adversely affected by the mining slowdown. However, there are signs of life in the industry with utilisation rates picking up. None come without their risks but all three could prove to be very profitable for investors willing to ignore the noise and patiently wait for value to be realised.

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Disclosure: At the time of publishing, Luke has a financial interest in MMA Offshore Limited.

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