At any time, the market price of shares is defined by both quantitative and qualitative measures of value.
That is, investors ascribe a proportionate value to a particular company's pool of assets and its future outlook. The qualitative assessment of future success or failure is more often than not the reason why shares will become over or under-valued.
Indeed, different industries and the broader sharemarket as a whole, will swing wildly from optimistic to pessimistic and back again.
Thus 'value investors' are likely to find stocks at 'bargain' prices in only the most unloved sectors, or at times of significant economic affliction (e.g. during the GFC). However identifying such opportunities is no easy feat.
Benjamin Graham, the father of value investing and mentor of Warren Buffett, had a few criteria he'd use to identify "bargain issues". He would conduct his tests on more than one stock and hold a vast array of qualifying companies in his portfolio at any one time (usually over 100!).
Graham believed purchasing a group of companies trading at a price less than the cost of their net current assets was a proven strategy for achieving worthwhile returns. Albeit over the long term.
Is Rio Tinto Limited (ASX: RIO) a bargain?
One of the unloved areas of the market for the past few years has been the mining sector, particularly those miners involved in iron ore. Unsurprisingly most analysts are negative on the sector given the bleak outlook for steel demand from China, coupled with the idea of hundreds of millions of tonnes of new supply hitting the seaborne market over the next couple of years.
Rio Tinto, the world's second largest iron ore miner, is believed to have the lowest breakeven costs per tonne, approximately $US43. However, the more than 40% falls in the iron ore spot price (down from $US135 per tonne last year) will definitely have a detrimental effect on its top line (revenue).
Indeed, this year shares in the mining giant are down 12.5% so far. For comparison, fellow iron ore miner Fortescue Metals Group Limited (ASX: FMG) is down 49%. It should be noted though, Fortescue's ore is of poorer quality (attracting a lower price) and costs more to produce.
Buy, Hold, or Sell?
Despite Rio shares fetching over $150 during the GFC (currently $59.50), it is not yet in bargain territory. Rio does not trade below its net current assets alone, nor does it trade below its tangible assets per share ($US22.35 at June 30 2014).
A better buy than Rio Tinto…
I have some exposure to Rio Tinto shares (see my disclosure below) but I'll be the first to admit the short-term outlook for the company looks bleak. Indeed, Rio is best left on the watchlist until investors are offered a much lower price (perhaps satisfying Graham's test), or market conditions improve. Be prepared, that could take a while!
