Finding Investment Firms Trading for Less Than the Value of Their Investments

Includes: EQS, GLAD, MVC
by: Lenny Grover

An interesting strategy for trading in BDCs is to identify firms whose market capitalizations are substantially less than the mark-to-market value of the company's investments. One of my most profitable trades was buying American Capital (NASDAQ:ACAS) at the height of the financial crisis, when its shares were trading at a relatively small fraction of its Net Asset Value. While that specific company was highly leveraged and trading at a discount because it was at risk of defaulting on its loans, it is possible that there are other similar firms that are trading at less substantial discounts but also have less of a risk of loss.

We can use the stock screener to find investment firms that are trading for less than their net asset value. We can use the following conditions:

RBSS Classification
"Investment Trusts"
Market Capitalization / Net Tangible Assets(NYSE:I)
Long Term Investments(I)
Market capitalization
Exchange Traded On
"Over The Counter"

This screen produces 143 results, as of 4/10/2011, but many of them are ETFs, closed end mutual funds, or special purpose acquisition companies (SPACs) that are less interesting. To help us order the results, we can rank all of the stocks in order of ascending:

Market capitalization / Net Tangible Assets(I)

and look for companies where this ratio is less than 1. For investment firms like BDCs, the ranking formula is essentially a measure of how divergent the company's market value is from the value of the assets on its balance sheet. By using an ascending order, we are listing the companies that this formula implies are most undervalued at the top of the list. Filtering through these results to extract the BDCs requires some patience but yields the following 3 firms:

Company Name
Market Cap / Net Tangible Assets
Equus Total Return
MVC Capital
Gladstone Capital

Equus Total Return (NYSE:EQS) appears to be the trading at the largest discount to NAV. In its 2010 annual report, the company reported a Net Asset Value of $4.29 per share relative to a current market price of $2.66 per share. The firm's total market cap is only $23.6M, so it lacks the scale of the other firms returned by our screen and is comparatively illiquid because it has a relatively low dollar volume of shares trading hands each day.

MVC Capital (NYSE:MVC) has net assets of $17.33 per share, according to its most recent quarterly report, while the stock is trading at $13.72 per share. According to an earlier Seeking Alpha article, it has a higher allocation to equity securities than many of the other BDCs and its portfolio performance is more volatile, as a result. However, while trading at a >20% discount to NAV, there is a decent margin of safety.

Gladstone Capital (NASDAQ:GLAD) is trading at only a slight discount to its NAV so it is not necessarily a fit for this strategy.

During the financial crisis, many of the BDCs, particularly those with leverage, traded at substantial discounts to NAV. Now, many are trading at a premium to NAV. Even though the current selection of stocks meeting this screen is relatively thin, it may make sense to run it periodically, particularly in leaner times, to see if there is once again a buying opportunity.

Disclosure: I am long ACAS.