In an era where financial information is vast and widely available, how does an investor determine underpriced securities? One method, brought to the forefront by Mario Gabelli, is to determine the Private Market Value of the company. Gabelli describes Private Market Value as, “the value an informed industrialist would pay to purchase assets with similar characteristics.”
Private market value adds a layer of knowledge about the underlying company by defining the intrinsic value of the company instead of by the price movement of the stock. PMV has other characteristics which make it a lucrative methodology for the value investor: 1) it includes a control premium, 2) it considers gaps in traditional accounting practices for both financial and operating data and 3) it factors a catalyst into the intrinsic value calculation.
Considering a catalyst into the valuation is a very important part of the Gabelli equation. For many investors, a catalyst may simply be that the market will recognize a higher valuation because of higher earnings or other performance related events. For Gabelli, the catalyst must either be specific or environmental. Specific catalysts are fundamental changes to the company in some way, such as management turnover, financial restructuring or expanding business lines. Environmental catalysts inherently affect the way the company does business by way of environmental, political, social or economic change.
Typically, in order to spot catalysts, the investor will look at overall current trends in the marketplace. For example, the demand for coal in Asia has been steadily increasing while the demand in the US has been dwindling. However, since China has increasing urban populations, coal companies are likely to benefit from growing exports. The catalyst has to do with social changes which stem from population trends.
After the catalyst has been identified, the PMV calculated, and the revenue streams evaluated, Gabelli compares the valuation to the current market value. If there is a vast difference, he determines whether there is a buying opportunity for the company. Similar to Gabelli, Third River analyzes the private market value of the companies we review for our portfolios. Private Market Value can be a very powerful tool for valuing small cap companies and determining if the sum of its parts is worth the stock price.
References: Greenwald, Kahn, Sonkin and van Biema, Value Investing, From Graham to Buffett and Beyond.