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Binary bets: Bargains or basket cases?

Most people agree the pricing of shares is now pretty efficient. When new information comes out, whether via headlines or official updates from a company, the estimated impact on future earnings is soon calculated and discounted back into the share price.
 
It’s not a perfect science, which is why prices still jig up and down. But there are no longer screamingly mispriced golden apples littering the market’s proverbial floor, like perhaps there were 50 years ago.

Three companies that could go either way

At any one time, however, there are a few shares around that seem resistant to fundamental analysis.
 
To oversimplify, we might call them binary bets.
 
I’m fascinated by these potential opportunities, precisely because the valuation seems to turn on much larger (or hairier!) outcomes than whether management is successful in reducing packaging costs by 3% or whatnot.
 
These are the cheap-looking companies under a cloud, distrusted by the market, and/or facing a future clouded in existence-threatening darkness.

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Sure, you can tweak your discounted cash flow model to reflect the latest sales numbers.
 
But at the back of your mind you’re wondering whether you’re rearranging deckchairs on the Titanic – or, on the other side, haggling about the cost of a mule in a gold rush!
 
Here are three companies from the FTSE 100 that might fit this definition. 

British Land (LSE: BLND)

Putting money into property is even older than investing in shares. The business model is simple – build or buy a property, do it up if required and keep it maintained, let it out, and pocket the rent. Oh, and periodically ask an estate agent what it’s all worth.
 
It’s hard to think of easier cash flows to model. Yet shares in British Land are trading at a discount of 30% to net assets, suggesting the market has its doubts about the future.
 
Think about it… if you could buy your own home with 30% knocked-off the price, would you even hesitate? Or would you grab two of them?
 
British Land seems to be dogged by two factors – short-term worries about a collapse in demand for property in the event of a disruptive Brexit, and a longer-term existential question about the future of Britain’s struggling bricks-and-mortar retailers.

If you think you can make the right call here, then perhaps you could bag a bargain?

BP (LSE: BP)

As with all commodity firms, the volatility of the oil price has always made calculating the value of BP shares a bit of a cross between accounting and astrology.
 
If the price of a barrel of oil can be $100 one year and $30 the next, what on earth should you plug into your spreadsheet?
 
In practice, analysts found workarounds.
 
For one thing, integrated majors like BP have natural hedges in their operations. If energy prices fall, dinging the value of the oil it extracts, then other parts of the business that benefit from low prices can compensate. Even more importantly, the long-term price of oil has generally been assumed to be higher than today, and more stable.
 
After all, there are finite reserves of oil, and this stuff fuels the global economy, right?
 
Well, maybe.
 
Concerns over fossil fuel use and calls to shift to renewables long ago left the fringes of student politics to enter mainstream reports from the Bank of England. Massive funds are divesting their coal, oil, and gas assets. And the calls to do so are not only coming from environmentalists – analysts, too, warn of the risks of spending shareholders’ billions discovering new reserves that might need to be left in the ground, either to tackle the climate emergency or because they’re no longer economical compared to wind and solar power.
 
It’s left BP shares yielding a whopping 6.7% and priced no higher than 10 years ago.
 
You can dig deep into BP’s accounts to figure out the breakeven price for extracting a barrel of oil and you can study global demand. But if future governments legislate fossil fuels out of existence, then all your hard work could be moot.

Burford Capital (LSE: BUR)

Litigation financing outfit Burford Capital has long been a controversial stock.
 
On the face of it, the high internal rate of return it enjoyed on the money it uses to back claims through the courts make it a dream for those who like numbers to underwrite their investment thesis. Fans also point to a quality and engaged management team, and the ease with which Burford has been able to raise new money for funding.
 
The company’s accounts were always quite opaque, however, which led to worries it was overstating its gains by prematurely booking profits. Things reached a climax last year when the short seller Muddy Waters released a report alleging Burford was deliberately misleading investors. The share price crashed 50% over the next few days.
 
As I write, Burford shares are priced just below £7, compared to around £15 the week before the short report was released and near £20 in summer 2018. Burford has defended its accounts, gone to court alleging market manipulation, and made various changes to its management team. But evidently the market is not yet convinced.
 
You could spend a lot of time creating a discounted cashflow model for Burford. But whether you enjoy a successful investment return from here will depend on whether the short-seller’s allegations have any merit.
 
How can investors make their mind up? A future secondary listing on the US NASDAQ market – under the eyes of US regulators – might help, but that’s been a while coming…

The lowdown on the down low

I’m not here to tell you to buy these three companies – nor to avoid them.
 
I just mean to highlight the need to determine what’s influencing the price of any company that appears to you to be cheap.
 
Because if you only look at the numbers, you might just be missing an existential crisis.

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Owain Bennallack does not own any of the shares mentioned. The Motley Fool UK has recommended British Land Co.