A huge amount of brain power and computing analysis is thrown at FTSE 100 stocks each month. So it’s tempting to think that these shares must always be fairly priced by the market.
Needless to say, I don’t share this view. I believe market sentiment, herd behaviour by fund managers and the impact of short-term news mean that bargains can still be found. Today I’d like to look at two stocks I believe could offer hidden value for shrewd investors.
A break-up bonus
Shares of insurance firm Old Mutual (LSE: OML) fell by 2% on Friday morning, after the group said that adjusted pre-tax operating profit rose by 37% to £969m during the period. Even a 32% increase in the interim dividend wasn’t enough to perk up the share price. So what’s happening?
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This impressive increase in profit was partly the result of cash received from the disposal of the group’s Old Mutual Asset Management division. This is part of a process of ‘managed separation’ which should see this conglomerate split up into four parts over the next couple of years.
The firm’s management expects to create value for shareholders by “unlocking the conglomerate discount”. What this means is simply that groups of businesses are often valued at less than the same businesses would be individually.
Old Mutual’s valuation certainly seems pretty modest to me. The stock trades at a 10% discount to the firm’s adjusted net asset value of 220p per share. A forecast P/E of 9.4 and prospective yield of 3.5% also seem quite cheap.
Of course, the risk for private investors is that it’s difficult for us to be sure of the value that will be created by the separation process. Shareholder returns may be less than expected.
However, management focus on shareholder value and a modest valuation mean that I’d be comfortable buying this stock at current levels.
The next blockbuster?
The term blockbuster is often used in the pharmaceutical industry. But it can apply elsewhere. Listed private equity firm 3i Group (LSE: III) has had a few blockbuster investments of its own.
The most recent was European budget retailer Action. 3i originally invested £107m in this group in 2011. The company has since received cash returns of £526m from Action and says that its stake in the firm is now worth £1,835m.
Blockbuster investments of this kind don’t come along every day. The big risk for 3i and its investors is that the group’s management will be tempted to overpay for new opportunities.
However, Simon Borrows, 3i’s chief executive, has shown great discipline with new investments in recent years. Assets sales have also been well-timed at largely profitable. This combination has seen the group’s share price rise by 150% in three years.
One risk is that the firm’s last-reported net asset value was just 604p per share. This means that the current share price of 940p prices the stock at a heady 1.6 times book value. The forecast dividend yield of 2.8% isn’t especially generous either.
The market has already priced in quite a bit of growth at 3i. This well-run company may continue to outperform the market, but I’m not sure there’s much hidden value left.
